Barriers to Entry: What Insurance Broker Bonds Reveal About the Economics of Occupational Licensing

Anyone thinking about entering a profession that requires a licence has to reckon with what that licence will actually cost before they've even finished the training needed to get it. Insurance brokers are a good example. The clearest data on this comes from the United States, where licensing costs have been unusually well documented by researchers — so the figures that follow are American, though the underlying economic principle applies just as directly to professional licensing in the UK. In California, a broker must obtain a $10,000 surety bond from the state's Department of Insurance before they can legally sell personal lines of insurance. In Texas, that figure is $25,000, and in Florida it's $50,000. These sums look modest set against the tuition, exam fees, and background checks that also have to be paid before a licence is granted, but they still amount to an economic barrier to entry — and that barrier is central to understanding why licensing requirements exist in the first place, and who they're really designed to protect." 

The Bond Costs Little. The Licence Around It Doesn't.

The surety bond itself is rarely the main expense of becoming an insurance broker. A broker with a decent credit history can typically secure a $10,000 California bond for $100–$150 a year, since most sureties price their premiums at 1–5% of the bond's face value. The real cost lies in everything else bundled around it: pre-licensing education, the state exam, a background check, and ongoing continuing education, all of which extend the overall duration of the process. Bonds are usually the last phase or step in a long process and often the least expensive. Still, they are instrumental in solving the legitimate concern surrounding a client's transfer of premium funds to a broker whose honesty and financial standing are challenging to substantiate. The screening function that the state performs protects clients by acting on their behalf.

Consumer Protection, or Protection for the People Already Licensed?

Since the 1950s, licensing requirements have consistently increased. In the United States, nearly one in four jobs now require a licence, more than are covered by minimum wage laws and union membership put together. The increase in licensing requirements is caused by two major influences. The first is legitimate; it is possible that having a minimum standard will provide consumers protection against incompetent or predatory practitioners. The second is less flattering; economists refer to it as regulatory capture. Many of the boards that issue licences are composed of individuals who already work within the profession being regulated, and therefore, they have a vested financial interest in maintaining a high bar for new entrants.

What a $200 Billion Deadweight Loss Actually Looks Like

The literature on this is fairly consistent, and studying something as modest as an insurance broker bond helps put the larger figures into perspective. According to Morris Kleiner, an economist often cited on this topic, licensing requirements impose an annual burden of approximately $200 billion on the US economy, resulting in about 2.85 million fewer jobs nationwide. Employment tends to decrease by 17%–29% when an occupation changes from one that does not require a licence to one that does. Additionally, licensed workers are much less likely to switch jobs, move, or create their own business compared to unlicensed workers. Smaller states generally experience losses of about $1 billion, while California’s estimated losses are more than $22 billion.

Deadweight loss is a straightforward concept; it is the subject of nearly every intermediate microeconomics course. Whenever supply is restricted, price rises, and quantity falls relative to what a competitive market would deliver, creating a trade-off. The value of that trade-off will be dependent upon the amount of protection that the requirement actually provides. For example, a $10,000 bond may provide protection against both those who would be considered dishonest and those who would not be able to pay if the bondholder were to default. In contrast, a continuing education requirement that primarily puts additional burdens on new entrants to the industry represents a form of rent extraction in the guise of consumer protection. The licensing literature has yet to differentiate between requirements that provide protection and those that represent financial gain for the licensing authority.