Why selling insurance is a terrible proposition

Discussion in 'Economics' started by garfangle, Sep 7, 2009.

  1. I believe sellers of insurance (the insurance cos.) will always lose money in the long run if they lose their ability to collude through regulation. Selling insurance is based on the idea that one collects premiums, invests those funds, and pays out to those who make legitimate claims.

    Profits are calculated based on how much you collect less how much you pay out. The assumption is that insurers can know how much risk they can take on and thus never be in a position to suffer catastrophic losses. While this may be true during times of calm, it is not true during times of crisis.

    A firm can be overwhelmed by claims (see Hurricane Andrew/Katrina or 9/11) and not have enough money to pay out legitimate policyholders. Moreover, should they try to raise premiums to offset their excessive losses, new or renewing businesses will defect to competing firms which did not suffer those losses and can afford to keep their premiums low. The inundated firm would be in a bind, unable to raise rates, yet enduring terrible losses and facing imminent bankruptcy.

    To avoid this fate, the industry embraces regulations that allow it to collude and keep out new firms. The regulations permit firms to price their products uniformly and impose sizable costs and burdens on new market entrants.