Why Are There So Many Insurance Companies?

There were nearly 6,000 insurance companies in the United States in 2015, which collectively wrote more than $1.2 trillion in premiums. It seems that the insurance industry would be ripe for consolidation, much like we've seen in the banking industry, where the number of banks has declined for decades.

One reason is that it's easy to start an insurance company, but difficult to wind one down. In this segment of Industry Focus: Financials, host Gaby Lapera and contributor Jordan Wathen discuss why there are so many insurers, and why insurance will remain competitive for many years to come.

Gaby Lapera: There are tons of insurance companies. Why?

Jordan Wathen: There are a lot of insurance companies. The first reason is, it's kind of the natural state of the insurance industry to have a lot of insurers. If you think about it, insurance is all about spreading risk around, and that's not just among the insurance companies' clients, but also among insurers. The world would be a worse place if there were 10 insurance companies who owned the market in one state and underwrote car insurance policies, or homeowners insurance, or whatever, just in one state rather than having a bunch of different companies compete in a bunch of different states and a bunch of different markets and spread the risks around that way. So I think the natural state of this industry is always going be very competitive. The second reason, actually, speaking of states, is that insurance companies are licensed in states. When you think about starting an insurance company, it's much easier than starting another financial institution, like a bank. The regulatory regime isn't nearly as strict on insurance companies as it is on, say, a bank. For that reason, it's easier to start an insurance company than it is a bank.

Lapera: Yeah. As you mentioned earlier, you were saying, with it being good that there's a lot of insurers, that ties into our conversation about reinsurance that we had at the front half of the show. The other thing that you mentioned is, it's kind of easy to start an insurance company, but it's really hard to get rid of an insurance company.

Wathen: Right. Winding down an insurance company is hard. One of the biggest benefits that you can have as an insurance company is scale -- that you're bigger and you support this massive customer-service organization, or whatever. To go down, to underwrite less insurance, is really hard to do. It's bad for employee morale, it's bad for the economics of the business. You have scale working against you as you get smaller. So it's hard to wind down an insurance company, to say the least.

Lapera: Yeah, and there are regulations around how to do that, which just makes it that much harder. You can't just wake up one day and be, like, "We're out of business, sorry everyone who has insurance with us!"

Wathen: Right. If you write insurance for five years, you can't just shut that down. You have to have someone to take over the policy. It's just not easy -- insurance is a long-run business and it's not easy to run something like that down. You have the investment portfolio to wind down. It's just a mess.

Lapera: Yeah. So that's why there's so many insurance companies. They're easy to start, they're hard to shut down, and it's good for everyone that there's more.

Wathen: And the tax benefits can be tremendous, too. This is a fun one. A bunch of hedge funds are starting reinsurance companies in Bermuda now, and they write a small amount of insurance so they can call themselves reinsurers, but really they're just hedge funds that are trying to get tax advantages. That's an interesting angle, too.

Lapera: Yeah. I think the answer to that question was a lot more complicated than I originally thought it would be. So I'm really happy for the person who asked that question.