Purchasing Insurance as a Game of Chance: What does your Homeowners ...

The core product that insurance consumers buy is a standard form contract.  Unlike virtually any other market, though, it is virtually impossible for purchasers of personal lines coverage (i.e. homeowners, renters, and auto insurance) to scrutinize this product before they purchase it.  Insurers only provide consumers with an actual insurance contract several weeks after they purchase coverage.  They generally do not make sample contracts available to consumers on the Internet or through insurance agents.  Marketing materials and other secondary literature from regulators and consumer organizations provide virtually no guidance about how different carriers’ policies differ.  And most states have essentially zero laws requiring insurers to provide any types of pre-sale disclosure to consumers regarding the scope of their coverage. 

How can this possibly be?  

The primary answer is that both insurance regulation and market mechanisms have long operated under the assumption that personal lines policies are completely uniform, meaning that disclosure just does not make sense.  This assumption was accurate in the 1940s and 50s when state insurance regulation was being molded into its present form.  The reason was that individual insurers were unable to accurately predict losses based solely on their own data.  In order to improve their capacity to predict losses, insurers pooled their loss data through industry organizations.  And in order to pool their data in this way, they needed to use the same policy forms.  As a result, the industry organizations that pooled insurers’ loss data also came to draft policy forms for the industry.   This process is one of the core explanations for why the insurance industry enjoys a limited exemption from antitrust law.  

The only problem is that homeowners insurance policies (and likely other personal lines insurance policies) are no longer any where close to uniform.   As I show in my forthcoming article, Reevaluating Standardized Insurance Policies, carriers' homeowners policies differ radically with respect to numerous important coverage provisions.  

How have insurers deviated from the presumptive industry policy given the supposed economic logic of uniformity?  The answer is simple: insurers have grown larger and technology has grown more sophisticated.  These trends mean that the largest insurers no longer need to rely on industry data to predict losses. As a result, they no longer need to utilize the standard industry insurance policy either.  Given these circumstances, it is perhaps not surprising that some of the largest insurers in America have substantially degraded the scope of the coverage they provide in their policies.  Yet neither market mechanisms nor regulators have taken action to allow consumers to assess which insurers have done this.    

Many of the solutions to this problem in personal lines markets are currently being implemented in health insurance markets as a result of the Patient Protection and Affordable Care Act (“ACA”).  First, the ACA requires regulators to devise standards for a summary of benefits and coverage explanation.   Insurance regulators have already done an admirable job developing such disclosures.  Second, the ACA establishes health insurance exchanges that will “facilitate” the purchase of insurance in part by providing consumers with tools for selecting among different carriers’ coverage options.   Third, the ACA sets a minimum coverage floor for all health insurance policies sold in the individual and small group markets, requiring that they provide “essential health benefits.”  To these, one could add the fairly obvious requirement that carriers make their insurance policies available one a pre-sale basis on their websites.