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Big on Profits, Low on Returns—Insurance, Says Andrew Tobias, Is America's Protection Racket

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Insurance has existed at least since Babylonian legal codes, which 3,700 years ago required that citizens be reimbursed for robbery and have their debts canceled if natural disaster ruined crops. Today policies cover everything from death to a pianist’s stubbed pinky. Indeed, Americans buy nearly half the insurance sold worldwide each year, and the industry has grown so massive it now employs three times as many people (1.8 million) as the U.S. Postal System and has more assets ($700 billion) than the nation’s top 50 corporations combined. Undaunted, financial writer Andrew Tobias, 34, has taken on the insurance behemoth in a new book, The Invisible Bankers (Linden Press/Simon & Schuster, $15.50). A native New Yorker, Tobias earned both a B.A. in Slavic languages and literature and an M.B.A. from Harvard before joining the staff of New York magazine in 1972. He is the author of two best-sellers: Fire and Ice, a biography of Revlon founder Charles Revson, and The Only Investment Guide You’ll Ever Need. Tobias, who lives alone on Manhattan’s Upper West Side, untangled some of the mysteries of America’s Gross National Premium for Allan Ripp of PEOPLE.

How powerful is the insurance industry?

Powerful enough to be exempt from federal trade and antitrust laws. In 1944, when the Supreme Court ruled that the insurance industry should be subject to such laws, the industry got Congress to pass a bill which in effect spares the insurance business from federal regulation. On the state level, Massachusetts, for example, has 400 registered lobbyists. Of them, Ford has one, Harvard has two and the insurance industry has 60. The insurance company usually gets what it wants.

How lucrative is insurance?

Extremely. State Farm has a larger capital base—more accumulated profits—than either Bank of America or Citicorp. The Prudential owns more buildings, including the Empire State Building, than any company in America. In recent years Sears, American Express and ITT have made more money from insurance than from retailing, credit cards or telecommunications.

As potential victims, don’t we want insurers to have a lot of money?

Unquestionably, insurance companies should be rich enough to pay our claims, unlike the 68 firms that went bankrupt after the Chicago fire of 1871. At its best, insurance spreads the risks against personal loss. Some publicly held insurers even pay healthy dividends. Even so, America’s 4,800 insurance companies often do their primary job with enormous inefficiency.

What kind of inefficiency?

U.S. policyholders paid some $200 billion in premiums in 1981—about $900 for every individual. But what was the return? Insurance companies regularly pay back 65¢ or 40¢ and in some cases only 10¢ for every premium dollar they take in. By comparison, Blue Cross uses 93¢ of every premium dollar to pay benefits.

Where does the premium money go?

Like savings banks, insurance companies invest our money in bonds or mortgages. They use our premium dollars plus the interest made on them to pay our claims, pay their expenses and make a profit. But whereas a savings bank is able to return on demand every dollar we deposit plus interest, insurance companies keep the interest plus a large chunk of our premiums. And they can take months or even years to reimburse policyholders.

How can such laggardly service and poor payoffs go unchecked?

The insurance-buying public usually has no idea of the poor value it gets. One credit card company—to take an extreme example—offers $250,000 worth of flight insurance to its cardholders for only $3. Sounds like a great deal, until you realize that the odds of being killed in a plane crash on a scheduled domestic flight are less than one in a million. Thus the insurer rakes in $3 million for every $300,000 to $400,000 it pays out in claims.

What about insurance that covers more common accidents?

Incredibly, auto insurance, which is required by law in most states, is still sold one policy at a time. A leading California auto insurer, for instance, has 70,560 different rates. Imagine how expensive Social Security or unemployment insurance would be if it were handled that way. More burdensome are the legions of adjusters and lawyers who can add months and subtract dollars in every disputed claim. As a result, honest policyholders who don’t inflate their claims receive less than 500 in benefits for every dollar they pay for auto insurance.

Do you see any alternatives?

Ideally, we should have a system under which every driver is automatically covered. This would eliminate the enormous cost of single-policy sales. Since so much personal-damage money is eaten up by fat litigation fees, such a plan should be completely no-fault. Such coverage could be sold automatically at the gas pumps on a pay-as-you-drive basis, with a 30¢ or 40¢ premium charge added to each gallon. An average motorist who drives 12,000 miles a year getting 20 miles to the gallon would be covered at a cost of about $300. We’d still be dishing out the same $40 billion in national premiums, only we’d get back so much more than we now do in benefits. At the very least we should have some form of group auto insurance.

How big a part does fraud play in affecting insurance rates and coverage?

Many people find it all too easy to file phony or padded claims, rationalizing that it’s their way of evening the score with the insurance companies. The pastor of one Chicago church filed 76 accident claims in four years and collected $85,000 before his scam was uncovered. Overall, fraud accounts for billions of dollars a year in claims. And you and I are paying for it. Fire insurance, as it is currently written, actually encourages arson—America’s hottest profit maker.

Is such a high ripoff rate inevitable?

It is as long as insurers keep up the incentives by failing to investigate thoroughly fraudulent claims or pay legitimate ones. One company denied disability to a stroke victim, claiming that “with crutches, a foot brace and an attendant, she could make occasional visits to the doctor,” and some insurers tried evading the claims of looting victims in New York’s 1977 blackout by insisting a riot had not happened. Bad faith on one side breeds bad faith on the other. The problem is that false claims only return to haunt us in the form of higher premiums.

What is the difference between whole life and term life insurance?

Term life insurance is simply that: insurance. If you die, they pay. The premium naturally goes up every time you renew as you grow older. In whole life, you are also building up an equity fund which you can borrow against or in your later years cash in. Your premiums start out considerably higher than term, but they remain constant for the duration of your policy.

Which is the better buy?

Most people should buy term insurance. Your dollar stretches much farther. Inflation rates have wiped out any savings benefits from whole life policies. Instead of paying $1,200 a year for $100,000 of whole life insurance coverage, a family should pay $200 for term and invest the difference, if they have it, where they have more control.

What can consumers do to make sure they’re properly insured?

The cardinal rule is to shop around. It’s one thing to pay a few dollars more for the same coverage, but some people are paying twice and three times what they have to. The second rule is to insure only against losses you can’t afford to bear yourself. In other words, opt for the highest deductible you can. It will lower your premium. Doing this, you will be able to take all but $100 of any uninsured loss as a tax deduction. Many families are paying for the right to make small claims, but not making them for fear of seeing their rates hiked or policies canceled.

Is the industry likely to reform itself?

No. There has to be a change in the law. For example, in almost every state it is illegal to sell low-cost group auto insurance, illegal for savings banks to sell low-cost life insurance, and illegal in all states for retailers of insurance to cut prices. The industry is beginning to feel pressure from consumers during the current economic crunch. Why should they make a poor investment when they can get a better return elsewhere—from treasury bonds or money market funds? This forces companies to improve their policies. Still, shoppers should beware: When buying insurance, an ounce of prevention may only be worth a half pound of cure.