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CHAPTER 9
Insurance Markets:
Economics and Issues
I. SUGGESTED CLASSROOM TIME: 60–75 MINUTES
II. CHAPTER OVERVIEW
This is the third of the four chapters devoted to describing the participants in the
insurance marketplace. This chapter specifically explores the economic forces at work that
shape and mold the market and economic landscape as well as consumer issues.
Because of the way the insurance marketplace works, self-professed consumerists in
the insurance area may create confusion for the consumer in the consumer’s pursuit of a
reasonable product at a competitive price. The economics of these forces are analyzed in
confounding factors, such as low-standard building codes, provide a foundation for the
crises. The portion of the chapter devoted to consumer protection sets forth and defines
the separate roles of the courts, the law, and the insurance commissioner. It should be
emphasized that it is the interaction of these separate units that provides protection to
Chapter 9/Insurance Markets: Economics and Issues 61
III. LECTURE OUTLINE
A. Introduction—there is considerable concern about the impact of the insurance
transaction on the public and on the role the government should play in insurance
regulation. This has been especially highlighted since the terrorist attack on the World
Trade Center and the Pentagon on September 11, 2001. This chapter provides an
overview of the economic laws and forces operating in the insurance marketplace.
1. The insurance market is a place where buyers and sellers meet to transact business.
B. Economic Theory
1. Supply and demand
a. Requirements for efficient market
1. Numerous independent sellers with a small market share who cannot
2. Supply and demand of insurance
a. Insurance demand inelastic—that is, if the price is lowered or raised, price
changes will not influence consumption that much. On the margin, people now
3. Historic problems involve availability and affordability of insurance.
a. High-risk automobile insurance—Assigned-risk automobile insurance plans
provide insurance for poor (bad) drivers who are no longer accepted by the
voluntary market. Some subsidization occurs to the extent that inadequate
62 Chapter 9/Insurance Markets: Economics and Issues
b. Property insurance FAIR plans—Fair Access to Insurance Requirements (FAIR)
plans mandate provision of property insurance in inner-city areas. Operated
since 1968, the plans are now in a majority of the states. By charging poorer
risks average rates, subsidization occurs. FAIR plans have lost money in most
states in most years. What are the alternatives? People can’t control
C. The Insurance Consumer
1. The insurance consumer is not well informed because of
a. The cost of obtaining information
b. The legal complexity of the contract—a necessity under our legal system
2. Industrial organization theory says that the more informed the consumer, the
higher the quality of information that will be provided by the producer. If
D. The Consumer’s Choice
The consumer ultimately has to make a series of choices in order to purchase a good
product.
1. Choosing the company
a. Financial strength is a matter of public record. Several financial rating firms
exist, e.g., Best’s Property and Casualty and Best’s Life and Health of the AM
Best Company, Standard & Poor’s, Weiss Research, and Moody’s Investor’s
Chapter 9/Insurance Markets: Economics and Issues 63
2. Choosing the agent
a. Somebody you can trust and understand—who can demonstrate her knowledge.
3. Choosing the policy
a. A function of needs: Until one has carefully analyzed the needs the policy can’t
be intelligently chosen.
b. Should be read and understood and conditions complied with.
4. Choosing the proper amount of insurance
a. Must begin with needs. Must look at the available assets or the value of the
assets at risk.
b. Must consider resources available to purchase insurance. Would a person be
better off to take a higher deductible and use the money saved to buy more
E. Consumer Protection: The role of the courts, the law, and the insurance commissioner
1. The courts
a. If the consumer feels promises not delivered, consumer may take the case to
court.
b. There are legitimate reasons for insurers to deny claims.
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2. The law
a. The Insurance Code of the various states sets rules of conduct.
2. New York Appleton Rule: Insurance companies operating in New York must
obey regulation wherever operating.
3. The insurance commissioner
a. Chief administrator in charge of insurance regulation in the state
F. Appendix: The Insurance Underwriting Cycle
1. Reference is to repeated cycles of lower prices (soft markets) and higher prices
(hard markets).
2. Underwriting results are a function of several factors.
a. Written premiums
4. Investment income can be the difference in achieving profitability.
5. Cash flow underwriting is a deliberate “loss leader” strategy that depends on
investment income.
IV. ANSWERS TO REVIEW QUESTIONS
1. Most markets consist of buyers and sellers. The chapter suggests that the
insurance market has three participants. Who is the third participant, and
what is its role in the market? There are two parties, buyers and sellers, in most
Chapter 9/Insurance Markets: Economics and Issues 65
2. What are the requirements for a perfectly competitive market? What is
one of the main benefits of perfect competition? The following are the
requirements for a perfectly competitive market: 1) Numerous independent sellers,
3. Describe an aspect of insurance that is not consistent with the
characteristics of competitive markets. Insurance companies must get
4. If insurers colluded and raised the price of insurance, what would you
predict would be the effect on the quantity of insurance sold? Explain your
answer. Raising the price of insurance can actually decrease the supply of insurance.
5. If the government made insurers lower the price of insurance 25 percent,
what would you predict would be the effect on the quantity of insurance
sold? Explain your answer. Lowering the price will tend to reduce the quantity
sold. Insurers will be reluctant to sell insurance coverage at below cost. In this case, a
6. What is a FAIR plan? How does it work? The FAIR Plan (Fair Access to
Insurance Requirements) is a federal-state insurance plan designed to provide
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7. Explain the purpose of assigned risk plans and JUAs in automobile
insurance. The purpose of assigned risk plans and joint underwriting associations
(JUAs) is to make automobile insurance available to individuals who cannot buy it in
the purely private insurance markets. The way these state plans work is to require each
8. Describe the problems caused by uninformed consumers in the insurance
market. Uninformed consumers create problems due to the fact that industries
dealing with uninformed consumers tend to maintain the status quo. The industry
9. How does the role of the courts differ from the role of the insurance com–
missioner in protecting the consumer? A combination of the courts, the
insurance commissioners, and the law provide the framework for insurance regulation.
Chapter 9/Insurance Markets: Economics and Issues 67
10. Describe the important factors to consider when choosing an insurance
company. The following are the important factors considered when one chooses an
insurance company:
11. Why is the lowest-priced insurance protection not necessarily the best one
to buy? The lowest-priced insurance contract may not necessarily be the best
alternative if it comes from a financially weak insurer, or one that provides only slight
12. What information do financial ratings firms provide? What are some
potential problems with their ratings? Consumers get a professional opinion of
the financial strength of the insurance company in question. There are several
professional rating firms, and there are potential conflicts and problems with the
A rule of thumb is that unranked companies, or those ranked lower than the highest
three ratings categories by the majority of the ratings firms, should be avoided, unless
the consumer has good reason to deal with a company without a rating or that has a
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13. Explain three common-sense rules for choosing the proper amount of
insurance. Three common-sense rules for choosing the proper amount insurance are:
1) Insure first those exposures to loss most likely to cause the greatest amount of
V. ANSWERS TO OBJECTIVE QUESTIONS
1. All except which of the following criteria are specified in the model for perfect
competition?
2. To make automobile insurance available to high-risk drivers, various states have used
all except which of the following approaches?
3. The most important choice a consumer must make when purchasing insurance is
4. Stare decisis means
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5. All except which of the following parties are participants in the insurance market?
6. Insurance consumers can get information about the financial strength of insurance
companies from
7. Which of the following designations is cannot be earned by insurance agents?
8. In most states, the insurance commissioner is
VI. IDEAS FOR INSTRUCTORS AND TEACHING METHODS
1. Select one of the most difficult insurance-related problems in your state. (In 2012, this
clearly involves health insurance and insurance coverage for catastrophic events.) Split
2. Have your students read some of the current popular consumerist writings in books
3. Collect brochures from local insurance agents about the products from the companies
they represent. Distribute copies of the material, and have the students analyze the
4. Create a standard package of insurance and assign one type (package) to each group of
students. The types of insurance should include homeowners, automobile, boat, life,
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and health. Have them call at least three agents to price the coverage for a standard
exposure. Report back to the class on the prices. This should demonstrate the
difficulty in selecting the “right” contract because they will find the prices are different
and the coverage varies as well.
5. Have students discuss and explain why the supply of insurance might decrease if prices
6. Select an insurance company and distribute the ratings and criteria from the various