Barriers to Private Insurance

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The American insurance industry is shackled by regulations and restrictions on all sides. Fred Smith, of the Competitive Enterprise Institute, assesses the harm done. Could Britain follow?

Modern society has become increasingly safety conscious. Apparently, the desire for security is highly income elastic per­haps because wealthier people have more to lose and respond accordingly. But, for whatever reasons, we face growing pressures to reduce risks and to ensure that those harmed by misadventure receive compensa­tion. The wisdom of this pressure is doubtful and in particular the rationality of targeting some risks over others can be called in question. Often specific risks are given priority over others seemingly of far larger size.

The growth of government safety programs has been significant in recent years. Federal and state governments have become extensively involved in providing insurance both directly and indirectly. As measured by revenues collected (‘Premiums’), govern­ment insurance equals or perhaps even exceeds private insurance. Regulation motivated by safety considera­tions has proliferated in recent decades including such major agencies as the Food and Drug Administration, the Environmental Protection Agency, and the Con­sumer Products Safety Commission. Finally the courts have come to play an important safety role ‘protect­ing’ the individual from ‘unconscionable’ contracts and compensating ‘victims’ via a transformed tort law. A growing body of research suggests that these ap­proaches are unlikely to improve safety. Too often government insurance neglects the important options of risk management and loss control; that neglect may actually reduce safety.

Government regulations have a predictable bias in favor of the status quo. New products are viewed as inherently more risky and are required to survive far more stringent safety tests. This bias delays the intro­duction of risk-reducing innovations and threatens to reduce safety overall. Overly conservative efforts to keep us safe from one type risk (the risk of introducing a dangerous product) can increase other risks (the risk that we forgo a safer technology) even more. Studies of some regulatory bodies (the Food and Drug Ad­ministration, for example) have demonstrated this effect — the safety losses resulting from the delays and rejections prompted by FDA rules have made us less safe!

Finally, the efforts of the courts to reduce risks are also questionable. The reduction of the right of free contract has limited innovation in risk management. If firms cannot assign risks via enforceable contracts, they will find it difficult to develop the specialized knowledge needed to assess risk adequately. Unless a risk reduction firm can shield its customers from its mistakes, it has little to sell. The parallel move to transform tort law from a system of corrective justice — an effort to identify and require restitution from al­leged wrongdoers — to a system of victim compensa­tion has created major difficulties for insurers while doing little to help most ‘victims’.

Why has there not been more involvement by the private sector in risk management? Several factors war­rant consideration. First, some risks may be simply too large or the risks too imprecise for the private sec­tor. But even here government action may be unwar­ranted; understanding of government failure remains limited. Moreover, even if the government fails, it may stop private insurance. The premiums charged by the government agencies may make it difficult or even impossible for a private firm to compete.