In elementary economic theory, competitive market pressures force people selling nearly identical products to offer them at about the same price. If one seller tries to raise price unduly, buyers will spurn his product and buy cheaper elsewhere. In real life, however, it doesn’t always work that way.
In my mail I just got an invitation to join a national association of retirees, even though I am not yet 60 and certainly not retired. The invitation included an offer of term life insurance at an annual cost of $17.90 per $1,000 of coverage. That would increase to $25.98 per thousand on my 60th birthday. That shocked me.
I have just dropped a policy from my economists’ society because its cost had jumped to $11 per thousand. My college teachers’ association policy still costs only $5.44 for the same amount of coverage. I can get a comparable policy from my reserve officers’ group for $6.73, with no increase for 10 years. Our farm mortgage lender would charge about $7.25. And another military service association offers me similar coverage for $5.96.
Why would any consumer buy insurance that costs them two to four times as much as equivalent coverage available elsewhere? Why would any vendor waste time trying to sell such uncompetitive coverage?
The answer, I mused, must be that the strategy for selling overpriced insurance is similar to that of a wolf in a singles bar. If you approach enough people, eventually someone will take you up on your offer, no matter how outrageous. The same strategy is behind the Nigerian “help me transfer $2 million” scam offers that clog everybody’s e-mail.
So what happened to those efficient, competitive markets taught in microeconomic courses? How can there be such “market failure”?
The answer is that perfectly competitive markets require good information. All buyers and all sellers need to know all the alternatives available to them, including prices charged by others. That evidently isn’t occurring in selling term insurance.
When markets don’t work, it is sometimes good for government to act. Should government ban a voluntary membership association from offering overpriced insurance?
Most people would find it absurd to crack down on a coffee shop that charges $5 for an espresso when the same thing is available across the street for $2, or a dealership with a pickup on sale for $30,000 that a competitor across town sells for $25,000. Why should insurance be any different?
On the other hand, most states’ insurance laws do prohibit agents from selling policies that are clearly inappropriate for the client in question. Minnesota Attorney General Lori Swanson has been particularly aggressive in pursuing insurers that sold variable annuities that clearly were not in the best interest of the retirees who bought them.
This distinction ultimately is a pragmatic one. When potential buyers can easily find alternative prices, the costs to society of regulating trade are greater than the benefits. I get many offers of insurance in the mail each year and new technology — the Internet — makes it easy for me to check my options. In any case, the price of the policy is only a few hundred dollars per year.
But when a salesperson pushes a product costing $300,000 to a retiree who has much less access to information, it is somewhat different. At some point, the benefit of regulation to society clearly outweighs the costs. Moreover, the standards that we apply to selling appropriate insurance probably should apply to mortgages. We are paying the cost for the lack of such rules right now.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.