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The role of government in the insurance industry

Hi friends,

I have a good friend of mine who works in the insurance industry. He analyzes risk and helps predict costs. We got into a heated debate, since he thinks government needs to take a role in the insurance industry. He is more informed on the insurance industry and policies since he works in the field, and he proposed a viewpoint that I would like you guys to respond to so I may propose to him a rebuttal. Here is the paragraph he wrote to me:

"The Terrorism Risk Insurance Act (TRIA) is an insurance treaty we have with the government. TRIA allows us to price insurance the way we do for many small businesses. If TRIA wasn't in place, we would have to raise our premiums because we wouldn't be protected if we experienced catastrophic losses from certain acts. Insurance is special in that you don't know the price of a product until later. All premiums are based on your expected losses, with some profit and commission and expense loads. Without the guarantee of TRIA ,we wouldn't be able to price as low as we do."

"In addition, the Floral Insurance Guarantee Association (FIGA) is extremely important in protecting those who are insured. For example, last year an insurer in Florida went insolvent, meaning they couldn't pay their outstanding claims. So what happens to the policy holders? They paid for insurance, but their insurer didn't price their business right, had too many losses, and went out of business. So the government stepped in and said, "Hey, all the solvent insurance companies still in business in Florida, based on how much premium you wrote in Florida, we're going to divide those total losses amongst all of you." The government looked out for the policy holders, and they allowed the companies to recoup that money in the form of a surcharge. Without government, in a truly "free-market", those policyholders would have been assed out from a product that they paid for, which was insurance for their business."

"What do you expect to happen if the government got out of the insurance business? We would have to raise our premiums at a cost to the consumer, and policyholders like the ones I demonstrated in the FIGA example would be completely screwed!"

So, for those of you more well versed in the topics of liberty, especially as it pertains to the insurance industry, I would really appreciate your input. How would you respond to these claims? How would things be handled in a free market in regards to insurance policies, prices of premiums, insurance companies that go out of business, etc.?

Thank you for your time!

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I don't buy the "what should the consumers" do argument.

In a free market there is no backstop. This is no different than what happened when banks went bankrupt prior to fiat currency and up until 1929.

If they made bad loans, their depositors got screwed when the bank went out of business. So guess what depositors did? They searched out reputable solid banks that did not make bad loans!

Doing that, the consumers forced the unbackstopped free market mechanism to only allow the reputable banks to survive and the ones where management made risky or dumb decisions to die.

That's what SHOULD happen. That's called the free market.

Yes, people will lose. More people will win. Under FREEDOM.

Freedom forces you to be more RESPONSIBLE for yourself and for your decisions.

That's why Glass-Steagall was passed during the depression

It separated banking, insurance and investment banking. When it was repealed all bets were off because the backstop was removed. Had they stuck to it and not bailed out the big banks, investment banks, insurance companies (AIG) and allowed things to take their course, we would have had a correction. But no, government jumped in along with the fed and re-inflated the bubble with fiat dollars. Now the financial system is more at risk than ever because of the huge debt.

Insurance is a free market, in most states

There are some things that are not commonly understood and the insurance business has done a very bad job communicating to the general public.
One thing is, insurance with few exceptions is governed and regulated by the states, there is no federal dept of insurance, thank God. Each State regulates the companies that are domiciled in that state, they make sure the reserves are adequate to pay claims, handle consumer complaints, and make sure that each company is operating according to the laws in that state. 50 laboratories of innovation, no concentration of authority and no meddling at the federal level.

Every state has a guarantee fund that each company choosing to do business in that state voluntarily enters into. So if a company can't pay its claims the others do, in a well regulated market that is very rare. Back in the day bookies did the same thing, if a bookie reneged on a placed bet, the other bookies would chip in and make good the bet, they didn't want to "wreck the game".

TRIA is voluntary, a business can wave this small charge. It came about after 9/11 in fear there would be multiple terror attacks costing billions and that hasn't happened. It probably should be ended.

Any federal insurance programs like flood insurance, managed by FEMA, or social security, have not had a very good track record.

I know many here are anti any regulation, but I look at it as a referee in a ball game. The ref makes sure the game is played fair and square according to the rules, but does not jump into the game and carry the ball or make an unfair advantage to a competing team.
very few states over regulate like Florida does and completely screws it up, other are much more efficient. I understand the state of Florida is now the #1 provider of auto insurance as they have through over regulation driven most of the private insurance companies out of the market. I understand that Florida provided insurance has no reserves, so if something goes wrong it will be a financial mess.

Never mind

Question answered


I view insurance as vehicles of speculation and by choice, do not participate in policy holdings.

Because I also see mandated insurance as a pre-supposition of guilt without innocence, I endorse its abolition.

Otherwise if a commercial business assumes excessive risk, it is their liability and no citizen should be coerced (via taxation) into rescuing their operation.

Additionally if the public wishes to assist others, IMO it can be done volitionally through municipal Trusts.

More here

There is some evidence to his

There is some evidence to his argument. Morality aside, there is a lot to suggest that the government backing of these insurance helps reduce costs...sometimes tremendously.

There are two key points. One is that government does not bail out the company...they bail out policyholders. If the company wants to remain solvent, they still have to adjust for risk....it is just that policyholders can have some piece of mind.

The other key point is when government provides limited liability coverage on companies. This is a morally questionable act, but there is little doubt that it lowers costs. For example, when the BP oil spill happened, BP used government laws to limit its liability. Furthermore, it is using the legal system to defer payment on damages. Fact of the matter is, if oil companies had to plan to pay for any potential damage, their costs would go through the roof; that would be evidenced by higher oil and gas prices. The government instead socializes that risk, greatly bringing down the overall cost to the economy.

This was part of the reason why Obama was heavily criticized for asking BP to pay all the damages. Because it sets the precedent that companies need to be fully liable for their actions, up to and including the seizing of the assets of the company managers. We might cheer that from a moral and "what is fair" point of view, but there is little doubt that that precedent has made oil and gas a lot more cautious. This leads to more costly preventative measures, less drilling, and higher prices.

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Insurance is not only socialism but it is a ponzi scheme as well

Insurance is not only socialism but it is a ponzi scheme as well. Actually it is like a Las Vegas Ponzi scheme.

I say if you play the game and lose then you lose. No bail out no refund. You made your bed so now sleep in it. Don't ask your government to steal money from me to pay for your bad decisions.

I bet this guy is all giddy that Obamacare is mandating insurance now.

For treaties with the government, ask a Native American

how that goes.

For losses due to certain catastrophic acts, it is common for insurance policies to preclude losses due to those (acts of war, acts of God, etc.).

On the general concept of getting government out of the insurance business, I would expect many more types of coverage to be available, at both higher and lower premium levels, if insurance companies are allowed to respond to market demand without government regulators dictating what and who they must cover.

The question of solvency of insurance companies could be addressed in a couple of ways, by having private agencies rate the insurance companies for solvency, and by having the insurance companies develop private re-insurance agreements among themselves for cost-sharing should a member not be able to meet payments to policyholders.

I'm sure there are other benefits and strategies for privatization - those were just the first I considered.

thanks for your response! Two

thanks for your response!

Two questions: how would the business model of an insurance company with higher premiums look? What would be the reasons for their higher premiums that would make consumers shop with them rather than people with lower premiums?

In regards to insolvency: are there any examples of the private market functioning in this way to protect against insolvency BEFORE government came into the picture. I have a feeling if I tell my friend how the private market could handle insolvency, he will say, "What makes you think this will happen? The private sector wasn't there to handle this before government stepped in to protect people against insolvency!"

blah blah blah, you know how it goes with people who love big government ;)

and thank you again for your response!

People would choose different price points for insurance

for the same reason they choose different price points for any product.
Premiums might vary due to several reasons - losses covered, deductibles, ease of filing claims, promptness of claim adjudication and payment, etc.

There is already a re-insurance market which is in effect an insurer of insurance companies - http://en.wikipedia.org/wiki/Reinsurance.

I can't speak to it's efficacy, but it's there.

You might ask your friend if it's OK to rob a solvent insurance company (its shareholders and policyholders) or taxpayers to pay the claims of an insolvent insurer. If your friend supports legalized theft, you may be wasting your time trying to convince him there is an alternative.

Spot on! I really appreciate

Spot on! I really appreciate this post. I am learning a lot about the free market in the insurance industry. Its amazing how people only see the insolvent insurer and the policyholders being reimbursed, but are not looking for free market solutions to this reimbursement.