"State" Insurance Makes a Comeback

The Dangers of Being a Commercial Not-For-Profit

Private property is theft--or so said French anarchist, Pierre-Joseph Proudhon way back in 1840. The implication is that public property is much more righteous.

The antipathy to private property lives on today. Actually, that's an understatement. It does not live on--it has triumphed. Most Unbelievers, and more than a few Believers, think that in a choice between the government owning, say, a power station and a private company, state ownership is superior and will produce superior results.

One animus of the prejudice against private ownership is that a private business exists to make a profit--therefore, it needs to charge more than actually required to produce its goods or services, which in turn means that its customers are being "ripped off" or stolen from. Privately owned businesses, therefore, exploit their customers. Ergo, private businesses are intrinsically evil, being institutions of exploitation and theft.

Now this is all nonsense, of course, but the truth or validity of an argument has never been allowed to get in the way of a "good story".

One device put forward to counter the purported implicit thievery of all private business has been the co-operative. Often times co-operatives eschew profit making and simply circulate cash back into the business. Customers are supposed to get a better deal from this. Prices are supposed to be lower. Another version of the co-operative idea is a mutual company--most often found in the insurance industry. Here the "noble idea" is that the policy holders "own" the company, which means that all trading surpluses are supposed to be put back into the company, thereby lowering premium costs for consumers. Win-win, non?

"We don't take a profit, so our trading surpluses drop straight to the policy holder's bottom line". AMI, the Christchurch based mutual insurance company which has just gone (virtually) bankrupt, used this argument--as all mutual's do. But it turns out (at least according to its critics) that it has been undercharging its policy holders for years (to fulfil the promises of a mutual having lower premium charges), while taking enormous risks in an aggressive expansion drive. According to the NZ Herald:

Bitterness has emerged against cash-strapped AMI Insurance for undercutting rivals' policy premiums then being forced into a $500 million Government bailout.

Competitors lashed out at what they said was a cheapskate business which grew too fast, took ridiculous risks, undercharged, failed to accumulate enough capital and was then hammered by the disaster. "They price everyone else out of the market with their stupid rates and then go running to the Government for a handout. Now it's just another socialist free ride for the people of Christchurch after AMI has been run like a cheap shop," said one angry insider.

There at least two great weaknesses in mutual companies. Firstly, over time they tend to disguise the true costs of doing business. Not under compulsion or obligation to make a profit, all surpluses (theoretically) get ploughed back into the company's operations, so that the company becomes bloated and wasteful of capital.

A profit making company intrinsically has a far higher discipline riding it. In the end, the owners of the business will only approve re-investing profits into the business, rather than distributing them to the owners, if the business will produce a greater return on those re-invested profits than the owners could earn in their own endeavours. This means that everyone is far more focused upon what the true costs of doing business are, and what the actual returns any new investment will generate. If the returns are likely insufficient, profits are unlikely to be reinvested. In a mutual, profits are reinvested willy nilly, without rigorous discipline.

The second core weakness in the mutual ownership structure is that when additional capital is needed--as is the case with AMI now--it has no-one to turn to. No investors, no shareholders, no real "soul-to-damn, butt-to-kick" owners. Moreover, no new investors, since any new investors will not be allowed to own the company.

So AMI has had to go begging to the Government. And the Government has "had" to bail them out since that is our system of mixed market socialism in New Zealand. If the problem is big enough the Government will end up owning it.

Now there is a straightforward solution to the inherent flaws in mutual insurance companies. The regulators ought to require a significantly higher level of capital reserves for all mutual companies on the ground that such companies cannot access capital markets for fresh capital in the event of a significant calamity. Such change would be a good outcome from a bad mess.

In the meantime, we also hope that the government will take full ownership rapidly, sell off the saleable parts of the business, and wind the rest down.

Profit is not theft. It is not a dirty word. It is the canary in the coal mine that alerts everyone to weakness and commercial dangers.