The Ultimate Commodity

Two economic facts make the insurance business peculiar:

1. Insurance is a commodity

2. Claims take a long time to pay

Being a commodity means margins are thin. Delayed claims payments means interest rates really matter and costs are very hard to estimate.

First, the commodity part.

Insurance companies are, economically speaking, simply pools of money. Mining companies have ore, oil companies have oil and insurance companies have money. All commodities. I like how Wikipedia approaches the definition: “a commodity is the same no matter who produces it”. How true.

But money is super weird stuff.

First, money is the medium of exchange, which means that we can use it for all anything you want. At “The Price is Right” insurance company, you’d claim for a boat if you broke your boat, a house if you broke your house or a hospital stay plus a vacation if you slipped a fell outside a convenience store. Not so elsewhere; you get moolah.

Second, unlike other commodities, it’s plentiful, unlimited and everyone has it in its pure form.

The second point means, conceptually, the barriers to entry are very low. Insurance isn’t like pencils, anyone can self-insure just by saving their money. Most of us don’t, though, because that would be impractical: we’d need help.

There was a time when insurers were mostly mutuals: basically bands of people/companies that agreed to pay each others’ losses. But this ain’t Soviet Russia, we don’t like paying for others’ screw-ups, so you’ve got to define very carefully when and how losses are covered. Now you’re worried about moral hazard and you build out the policy language (rules), infrastructure (payments and records), staff (audit, etc) and management to keep things straight.

Wait, that’s an insurance company!