Arguments that the insurance industry is inefficient commonly point to variation in the ratio of operating expenses to premiums across companies and allege that the nationwide expense ratio is excessive. It is claimed that inefficient insurers are not removed from the market because of price-fixing and because consumers have difficulty in comparing prices.

Table 7 presents evidence of operating expenses and loss costs relative to earned premiums for private passenger auto insurance. While results are shown for Michigan and for the nation, it should be emphasized that expenses and investment income are allocated to Michigan in proportion to premium volume (or incurred losses). They need not equal the actual values (which are unavailable). Results are shown for liability-related coverages (bodily injury and property damage liability, personal injury protection, and uninsured motorists coverage) and for physical damage coverages (collision and comprehensive). As can be seen, insurance company expenses are small relative to loss costs, and the breakdown suggests that the potential reduction in premiums from reducing claim costs greatly exceeds the reduction that would result from reducing operating expenses. [94]

The argument that variation in expense ratios among insurers necessarily indicates inefficiency fails to recognize that different expense ratios commonly are associated with different levels of service. [95] Critics of the industry often point to the low expense ratio for United Services Auto Association (USAA), a mail order insurer that only writes auto coverage for current or retired military personnel. The implication of the argument is that all insurance could be purchased through the mail at lower cost. There is no recognition of the role played by agents in a competitive insurance market, or of why an insurer like USAA that is purported to be more efficient does not expand its writings to other consumer groups.

In a competitive market, firms that choose inefficient operating methods are not rewarded and eventually disappear. Since firms that introduce cost-saving innovations can earn large profits, a substantial incentive exists for firms to minimize costs. In the final analysis, the argument that the industry is grossly inefficient presumes an absence of competition. If a large part of the market could be served at lower cost, why does some company not do so given the immense profit potential? Why do all consumers not flock to the lower cost insurers?

One possible reason that inefficient insurers could survive in the market is that consumers could find it difficult to identify low cost insurers. Some authors have argued that it is difficult for consumers to compare prices. [96] A number of states, including Michigan, make price information available to consumers to assist in comparison shopping. [97] However, it is highly unlikely that inefficiency of the magnitude alleged by consumer advocates could persist in the auto insurance market due to costly consumer search. Moreover, to the extent that comparison shopping is difficult enough for consumers to justify action by the government, the preferred mode of regulation would be increased information disclosure rather than restrictions on insurer expense levels. [98]