Does Anybody Know How to Fix the Industry's Image Problem?

The insurance industry continues to get a bad rap, considered by most consumers as a necessary evil. This view was validated last week by a Knowledge @ Wharton blog, which states that insurance is the “most misunderstood industry.” What’s significant about their statement, however, isn’t that it includes regulators among those clueless about how our industry works; it’s that it includes insurance executives.

In a new book titled, "Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry," Wharton Professors Howard Kunreuther and Mark Pauly join Urban Institute researcher Stacey McMorrow in a study of consumers, insurance leaders and policymakers. Their conclusion? All three groups illustrate an “overall failure to grasp how insurance can fulfill the roles it is designed to play: reducing future losses and financially protecting those at risk.”

We may expect to see political bias in the decisions handed down by policymakers. But the authors contend that executives also bring certain behavioral biases to their understanding of how the insurance industry works.

The bloggers note the terrorist attack of 9/11 as an example of insurance leaders pulling out of the commercial lines market in New York. Rather than adjusting their premiums to better reflect an underwriting discipline that matches the risk, insurers cited losses related to terrorism being completely uninsurable. This assertion makes a couple of questionable assumptions: the risk event was unpredicted and represented an incident that had no previous experience, and insurance executives are risk averse. Does the example (9/11) given by the bloggers mean that actuarial science, expert underwriting discipline and sound business leadership were not in place when the World Trade Center Towers were destroyed? Of course not. In any event, the Terrorism Risk Insurance Act (TRIA) of 2002 provided saving grace—albeit government-controlled saving grace.

Speaking of the government, thanks to state regulators, premiums are often constrained because lawmakers worry that insurance will not be affordable to the masses, say the bloggers. The blog offers Florida’s Citizens, the insurer of last resort, as the example. As the leading carriers withdrew from Florida’s shores citing an inability to compete, the highly state-subsidized Citizens makes coverage possible. What taxpayers in Florida don’t realize, however, is that their pocketbooks will be tapped to help offset losses if the state is hit by another devastating hurricane.

Meanwhile, the industry is trying to engage consumers who tend to view insurance as an investment rather than what’s it’s designed to do: protect against loss. “If, after several years, one doesn’t make a claim, there is a feeling that one’s premium has been wasted,” say the bloggers. In suit, these consumers don’t tend to voluntarily purchase insurance to protect against risk or serious loss.

The bottom line: According to the bloggers, there is a tendency for those at risk to “assume that disaster losses or major health related expenses will not happen to them.” Only after suffering a loss will consumers voluntarily buy insurance, they stated.

Yet, using the logic above, following a disaster insurers may still decide to restrict coverage, and state regulators may still decide to block private carriers from charging premiums that reflect the actual risk. The circle is yet unbroken.

The dichotomy here is that the insurance industry is still considered the largest in the world, and has shown no signs of relinquishing that title. So if the main goal of insurance is to reduce future losses and financially protect those at risk, perhaps the bloggers are right: consumers and regulators don’t understand how insurance works. But my money is on insurance executives, who understand too well.

Pat Speer is an editorial consultant for Insurance Networking News.

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