Why Are There So Many Insurance Companies?

By Motley Fool StaffMarketsFool.com

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.

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A full transcript follows the video.

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This video was recorded on May 22, 2017.

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

Jordan Wathen:There area lot of insurance companies. Thefirst 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 justamong the insurance companies' clients, but also among insurers. The worldwould be a worse place if there were 10 insurance companies who owned the market in one state and underwrote car insurance policies, orhomeowners insurance, or whatever, just in one state rather than having a bunch of different companies compete in a bunch of different states anda bunch of different markets and spread the risks around that way. So I think the natural state of this industry is always going bevery competitive. Thesecond reason, actually, speaking of states, is thatinsurance companies are licensed in states. Whenyou think about starting an insurance company, it'smuch easier than starting another financial institution, like a bank. Theregulatory regime isn't nearly as strict oninsurance 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. Asyou 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 thefront half of the show. Theother thing that you mentioned is, it'skind 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 biggestbenefits that you can have as an insurance company is scale -- that you're bigger and yousupport this massive customer-service organization, or whatever. To go down, to underwrite less insurance, is really hard to do. It's bad foremployee morale, it'sbad for the economics of the business. You havescale 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 aroundhow to do that, whichjust makes it that much harder. Youcan't just wake up one day and be, like, "We'reout of business, sorry everyone who hasinsurance with us!"

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

Lapera:Yeah. So that's whythere's so many insurance companies. They'reeasy to start, they're hard to shut down, andit's good for everyone that there's more.

Wathen:And thetax benefits can be tremendous, too. This is a fun one. Abunch ofhedge 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'rejust hedge fundsthat are trying to get tax advantages. That's aninteresting angle, too.

Lapera:Yeah. I think theanswer to that questionwas a lot more complicated thanI originally thought it would be. So I'm reallyhappy for the person who asked that question.

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