Your Insurer Is Paid to Fail You

Insurance is one of the genuinely good ideas humanity has had. Many people who each face a small chance of ruin pool their money, and the few who are ruined are made whole by the many who were not. Nothing in what follows is an argument against that idea. It is an argument about who was put in charge of it.

The Incentive Runs Backwards

An insurance company collects premiums and pays claims. Its profit is the difference. Every claim it pays reduces the profit; every claim it manages not to pay increases it.

State it that plainly and the problem is visible. The company is paid, at the margin, for failing the person it insures. Not by conspiracy, and not because insurance executives are worse than other people. By arithmetic. A firm that finds a lawful way to deny ten per cent more claims is a more profitable firm, and its managers are promoted for finding it.

So the industry develops what you would expect it to develop: fine print, exclusions, a claims department whose job is to say no, delays that make people give up, and an internal culture in which the customer at the moment of need is the adversary. None of this is a scandal in any one company. It is the equilibrium.

Selling Fear Is the Other Half

The second half of the model is on the sales side, and it is subtler.

Insurance sells protection against the unknown, and the unknown is frightening, and frightened people over-buy. The industry knows this and prices accordingly. A great deal of what is sold is not pooling of genuine catastrophic risk, which is the good idea, but coverage of small, likely, affordable losses at a large premium: extended warranties, phone insurance, travel insurance sold at the checkout. These are not insurance in the useful sense. They are a tax on anxiety, collected by people who are good at producing the anxiety.

Combine the two halves. The customer is oversold on the way in and underpaid on the way out. The pooling that makes insurance worthwhile happens in the middle, and the firm extracts from both ends of it.

Why Regulation Has Not Fixed This

Everybody knows the above, so there are regulators. Why has it not worked?

Because the regulator is captured in the ordinary way, and the ordinary way is enough. The industry is organised, permanent and expert; the customers are unorganised, transient and ignorant of the fine print until the day they need it. The people who write the rules were, or will be, employed by the people the rules govern. The industry funds the campaigns of the legislators who oversee the regulator. This is the same structure I have described for the business cycle and it produces the same result: rules that look like supervision and function as a licence.

And the one form of insurance that most clearly should be run as pure pooling, health, is in many countries the one where the extractive model is strongest, because it is where fear is greatest and the customer least able to shop around.

What a Reset Would Look Like

If the diagnosis is incentives, the remedy is incentives, and the shape is not mysterious.

• Pay for pooling, not for denial. A mutual, owned by the insured, has no shareholder to reward for refusing a claim. Mutuals exist and have existed for centuries; they were driven to the margins, not disproved.
• Make denial expensive. A claim wrongly denied should cost the insurer a multiple of the claim, automatically, without the customer having to sue. The current asymmetry, where the cost of a wrongful denial is at most the claim itself and usually nothing, is what makes denial the rational default.
• Separate catastrophe from convenience. Genuine pooling of ruinous risk could be treated as a utility; the anxiety products could be labelled for what they are.
• Publish the ratio. Every insurer should have to display, at the point of sale, what fraction of premiums it paid out last year. That single number tells the customer what he is actually buying.

None of this is radical. Every item has been proposed somewhere and adopted almost nowhere.

Why It Takes a Direct Vote

Here is where the argument stops being about insurance.

Every reform above is against the interest of a concentrated, wealthy, organised industry and in the interest of a diffuse public that thinks about insurance once a year. That is precisely the configuration in which representative government does not act. The legislator who proposes it gets no thanks from the public, which does not follow the issue, and gets a well-funded opponent at the next election.

The reforms are popular and impossible, and they are impossible because they are only popular. Popularity is not a currency in a system where a few thousand people decide and a few hundred lobby them.

A public voting directly on the question has no such problem. It does not need to be re-elected by the industry. It has to live with the claims department. Put the four items above to a vote and I would expect them to pass by a large margin in any country I can think of. That they never will be put to a vote, under the system we have, is the whole point.