- Economics of Insurance: Wenn der Staat sich einmischt/ Artikel mises.org (engl.) - - Elli -, 13.01.2004, 18:56
Economics of Insurance: Wenn der Staat sich einmischt/ Artikel mises.org (engl.)
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<font color="#002864" size="1" face="Verdana">http://www.mises.org/fullstory.asp?control=1410</font>
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<font face="Verdana" size="2"><font color="#002864" size="5"><strong>Economics of Insurance: The Case of New Jersey</strong></font>
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<p class="MsoBodyText"><font face="Verdana, Helvetica" size="4">by D.W.
MacKenzie</font>
<p class="MsoBodyText"><font face="Verdana">[Posted January 13, 2004]</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2"><img alt src="http://www.mises.org/images3/njplate.gif" align="right" border="0" width="274" height="144">The
New Jersey legislature recently responded to calls for reforming state
automobile laws. Some claim that these laws will increase competition. Given
the track record of this legislature in regulating auto insurance, there are
good reasons to be wary of this legislation. Does it really improve this
situation overall, or is it just another payoff to special interests? The
answering of this question requires some analysis of the New Jersey auto
insurance system.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">New Jersey has
the dubious distinction of having the worst automobile insurance system in
America. It is literally the most expensive, and provides poor service to its
customers. Despite these high premiums, many automobile insurance companies
have exited this market. In the past ten years, twenty insurers have left New
Jersey.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The reasons
for this exodus are clear. New Jersey regulations establish transfers that
create perverse incentives. New Jersey law requires that insurance companies
take all comers, even those with the worst driving records. This forces New
Jersey insurers to subsidize bad drivers.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The New Jersey
'no fault' system increases insurance costs considerably. If you have an
accident in New Jersey, you can move your case forward at the expense of the
insurance industry. Your insurance company pays for medical expenses and lost
wages. Lawyers collect fees on the basis of New Jersey's regressive
contingency system—they take a percentage of the damages that declines with
the size of the award.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">However, the
insured has no out of pocket expenses (other than past insurance premiums) and
bears no legal risk in the courtroom, and there is a very low threshold for
instigating litigation. The only thing one must worry about after an accident
is an increase in their future insurance rates—if they are deemed
responsible for the accident.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Under New
Jersey law, there need not be any verifiable evidence of injury. New Jersey
drivers can be paid for pain and suffering after accidents. While there is no
doubt that many accident victims do endure pain and suffering, drivers can
claim that they have an undetectable neck injury and receive considerable sums
of money. The New Jersey system encourages frivolous and fraudulent lawsuits.
Lawyers benefit much from this litigious system, but legal expenses are a
significant part of the reason for New Jersey's high insurance rates.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The state has
regulated insurance rates and profit levels. The excess profit law mandated
that insurers never earn 'too much' profit in a year. This law ignores the
fact that the fortunes of business rise and fall. Lean years offset years of
high profits. By eliminating the peaks, this law makes the troughs in profits
unbearable. It also ignores the fact that markets have their own excess profit
law—competition. So long as free entry and exit exists in markets, incumbent
businesses can earn only competitive rates of profit. This means that they
will earn only enough to keep them interested in remaining in the market for
selling insurance—the equivalent of what they would earn in their next best
opportunity.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Rate control
was supposed to prevent excessive rates, but it is clear that this effort
failed. Rates in New Jersey are the highest in the nation, yet they are still
not high enough to keep insurers from leaving the state.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The state also
has withdrawal restrictions. Legal restrictions inhibit exit from the State's
existing insurance providers. Insurance companies must exhibit extreme
financial hardship or pay another insurer to take its place before it can
leave the state.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">This is a
classic example of governmental regulation leading to appalling results. These
results have propelled efforts to reform the auto insurance system in New
Jersey. Recently, New Jersey governor McGreevy signed a law that reforms this
system. This new law is supposed to improve automobile rates by introducing
greater competition.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">The New Jersey
Automobile Insurance Competition and Choice Act of 2003 is supposed to
introduce greater competition into the New Jersey automobile insurance market.
It does this by reforming"a regulatory system that stifles competition
and has resulted in fewer and fewer automobile insurers doing business in the
State." This act declares"The reduction in the number of automobile
insurers doing business in the State has resulted in fewer choices for
consumers and reduced competition, and any further reduction in insurers will
jeopardize the availability of automobile insurance for the public and will
undermine the continued economic development of the State."</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">The New Jersey
legislature has determined that"a modernized regulatory system that
promotes robust competition among insurers will better serve the needs and
interests of consumers". Changes in the current system will attend to the
demands of New Jersey drivers by preventing the diminution of the number of
current insurers and encouraging the entry of new insurers to the state.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">This reasoning
has a superficial appeal. When multiple sellers compete for customers, these
customers get lower prices and higher quality. The more competitors there are,
the more competition exists. So, larger numbers of competitors automatically
translate into better outcomes for consumers. Economist Abba Lerner argues
that markets should be judged by the standard of perfect competition.
Without a large number of competitors, sellers held 'market power' and could
exploit consumers with high prices. Increasing the number of actual sellers
increases the welfare of consumers in a mechanical fashion. The absence of a
large number of sellers supposedly warrants governmental intervention to reign
in the use of market power.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The reality of
the market process is somewhat different. The actual number of competitors in
a market is not nearly as important as the conditions for market entry and
exit. As economist Friedrich Hayek argued, competition is a dynamic and
rivalrous process, where people discover the best prices and products.
Competition disseminates information and allows people to form opinions about
what is best for their interests. Market conditions change continually, so
competitors must actively compete through time. Lerner's static conception of
perfect competition fails to appreciate the dynamic nature of markets. It also
sets an absurdly high standard of perfection for market performance.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Economists
William Baumol and Harold Demsetz emphasize the importance of barriers to
entry and exit in markets. So long as free entry and exit prevails, sellers
will serve consumers well. Even a few competitors can compete intensely for
market share. Even a monopolist will have to price his products competitively
or face new competitors, when entry barriers are low. The lesson here is that potential
competitors are just as good as actual competitors as far as consumers are
concerned.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The idea that
increasing the number of insurers in New Jersey will necessarily help
consumers is false. This need not be true. To see if it is true, we must
examine the content of this new legislation.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">This law asserts that a
competitive market"should provide timely and accurate information as to
price, solvency and market conduct, so that consumers can enjoy the full
benefits of the marketplace." It insists that"the State retain the
necessary regulatory authority to protect consumers and insure that the
competitive market fairly and adequately serves consumers." To do this,
this law establishes a 13-member commission on insurance competition within
the New Jersey Department of Banking and Insurance. This commission will
implement a consumer information system and protect consumers from unfair and
anticompetitive insurance practices.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The state will
determine how competitive the insurance market is by examining the number of
actual insurance sellers, the degree of industrial concentration, the
dominance of any one insurer in terms of market share, financial or economic
barriers to entry, consumer access to information, and the availability of
coverage to consumers. In other words, this legislation substitutes one form
of detailed regulation for another. The questions that this fact raises are
will this form of regulation work better and why do legislators not simply
pursue real deregulation.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Absent from
the list of possible sources of monopoly pricing are political barriers
to entry. This legislation accepts the view that private interests can use 'market
power', the control of information, and practices like predatory pricing to
establish monopoly control of insurance markets. It ignores even the
possibility that high market share can result from superior efficiency rather
than supposed market power. It also ignores even the possibility that
political factors can stifle competition.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The control of
information by regulators opens additional opportunities for abuse. Controls
over practices like advertising tend to increase consumer prices</font><a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1410#_ftn1" name="_ftnref1"><span class="MsoFootnoteReference"><font face="Verdana, Helvetica" size="2">[1]</font></span></a><font face="Verdana, Helvetica" size="2">.
There is a market for information on goods, as well as for goods themselves.
As previously mentioned, the competitive process is a process of informing
consumers. Control over information by the state can easily be abused.
Politically influential businesses can restrict information on their
competitors.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Worse still,
economist George Stigler and Sam Peltzman have proven that private businesses
can 'capture' regulators and use them to inhibit competition. Regulation can
be abused to benefit the very businesses that it supposed to reign in.
Existing insurers can use their political influence to harm entrants, provided
that they have access to those who regulate the insurance market.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">It is not necessarily
the case that private insurers have such political influence. However, in this
case they surely do. This law passed thanks to the lobbying efforts of a
coalition that includes the National Association of Independent Insurers,
Insurance Council of New Jersey, American Insurance Association, New Jersey
Chamber of Commerce, Independent Insurance Agents of New Jersey, National
Association of Mutual Insurance Companies, Professional Insurance Agents of
New Jersey, and the Commerce and Industry Association of New Jersey. Why
should we expect such a coalition to push for reforms that benefit consumers
rather than themselves?</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The details of
this law indicate that it serves business, rather than consumer interests. It
eliminates the 'take all comers' law. It also eliminates a 1$ a day medical
policy for poor drivers. Such measures lower costs, but not necessarily prices.
The regulations that this new law creates do open opportunities for abuse.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">The notion
that market concentration and financial or economic barriers implies
monopolistic pricing depends upon faulty reasoning, but affords regulators the
power to punish companies that act competitively. Insurers that have low rates
and gain high market shares can be accused of predation, where they underprice
their products to gain market share. Once having gained this mysterious
commodity known as 'market power', they can raise their rates. This
legislation could easily serve as cover for efforts by insurers to subvert
competition and keep their rates above competitive levels. Insurance rates may
stabilize or even fall due to this regulation, but they may still remain well
above competitive levels.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">All of this
should come as little surprise.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Narrow special
interests, like insurance companies, have an edge over broader interest in
lobbying, like consumers. Smaller groups can organize for group action more
easily, and therefore have undue influence on policy</font><a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1410#_ftn2" name="_ftnref2"><span class="MsoFootnoteReference"><font face="Verdana, Helvetica" size="2">[2]</font></span></a><font face="Verdana, Helvetica" size="2">.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">Thus, there
are good reasons to expect that this legislation is merely an effort by the
insurance industry to increase its profits by avoiding competition. It
addresses some serious cost issues in New Jersey's present insurance system.
Yet, it leaves other issues alone, and opens more opportunities for abuse.
This new law may very well improve the market for auto insurance in New Jersey
overall. However, this does not mean that it is the best possible type of
reform.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica" size="2">As economists
Ludwig von Mises and Friedrich Hayek taught us all, competition in markets
provides the best basis for allocating scarce resources. Economists Mancur
Olson and Gordon Tullock have shown how the politicization of markets by
regulation favors special interests and leads to a wasteful competition over
income transfers. The general principles of economic science indicate that the
past failures of insurance regulation in New Jersey were not accidental, and
will not be remedied by further state action. This new law in New Jersey seems
to be just another such effort on behalf of special interests. Instead of
focusing on serving its customers, New Jersey insurers are expending resources
on lobbying the State Legislature for favorable legislation.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">Proponents of this law
have tried to make it sound like deregulation that aims towards establishing
competitive free markets. This is really nothing but a change in the form of
regulation. Hopefully, this new law will improve upon the current situation in
N.J. There is certainly a great deal of room for positive change in this
industry.</font>
<p class="MsoBodyText"><font face="Verdana, Helvetica">Given the failure of
regulation in the past, we should view new forms of regulation with great
skepticism. This bill will likely help the insurers who pushed for it. This
may benefit consumers to some extent, by stemming the outflow of insurance
companies. We should, however, remember that there is no real substitute for
actual competition in truly free markets.</font>
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<font bookman="true" old="true"><font face="Verdana, Helvetica" size="2">D.W.
MacKenzie teaches economics at Ramapo College. Send him</font> <font face="Verdana, Helvetica" size="2">MAIL</font><font face="Verdana, Helvetica" size="2"> and
see his Mises.org</font> <font face="Verdana, Helvetica" size="2">Daily
Articles Archive</font><font face="Verdana, Helvetica" size="2">.</font></font>
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<div class="MsoBodyText" id="ftn1">
<p class="MsoBodyText"><a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1410#_ftnref1" name="_ftn1"><span class="MsoFootnoteReference"><font face="Verdana, Helvetica" size="2">[1]</font></span></a>
<font face="Verdana, Helvetica" size="2">See Telser (1964) and Benham
(1972).</font>
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<div class="MsoBodyText" id="ftn2">
<p class="MsoBodyText"><a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1410#_ftnref2" name="_ftn2"><span class="MsoFootnoteReference"><font face="Verdana, Helvetica" size="2">[2]</font></span></a>
<font face="Verdana, Helvetica" size="2">See Mancur Olson in <em>The Logic
of Collective Action</em> (1965).
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