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💸 '''Frictional cost''' refers to the expenses and inefficiencies that reduce the net value delivered by the [[Definition:Insurance | insurance]] mechanism — the gap between the [[Definition:Insurance premium | premiums]] collected and the [[Definition:Insurance claim | claims]] dollars ultimately returned to [[Definition:Policyholder | policyholders]]. In insurance economics, these costs include [[Definition:Underwriting | underwriting]] and [[Definition:Claims management | claims administration]] expenses, [[Definition:Insurance agent | agent]] and [[Definition:Insurance broker | broker]] [[Definition:Commission (insurance) | commissions]], [[Definition:Insurance regulation | regulatory]] compliance overhead, [[Definition:Insurance premium tax (IPT) | premium taxes]], and the cost of holding [[Definition:Regulatory capital | regulatory capital]]. The concept is borrowed from financial economics, where friction describes anything that prevents a market from operating at theoretical efficiency, but in insurance it carries particular weight because the industry's entire value proposition rests on pooling and redistributing risk at a cost lower than the alternative.

⚙️ These costs manifest at every stage of the [[Definition:Insurance value chain | insurance value chain]]. An [[Definition:Insurance carrier | insurer]] must invest in policy issuance systems, maintain [[Definition:Reserve (insurance) | reserves]], pay intermediaries, fund [[Definition:Loss adjustment expense (LAE) | loss adjustment]], and satisfy [[Definition:Solvency | solvency]] requirements — all before a single claim dollar reaches the injured party. In [[Definition:Reinsurance | reinsurance]], additional layers of friction accumulate as premiums pass through [[Definition:Ceding company | ceding companies]], retrocessionaires, and [[Definition:Insurance-linked security (ILS) | capital-market vehicles]], each extracting fees and requiring their own administrative infrastructure. Analysts sometimes express frictional cost as the difference between a carrier's combined ratio and 100%, or they measure it as the portion of each premium dollar consumed by non-loss expenditures.

📉 Understanding frictional cost is essential for anyone evaluating the competitiveness of insurance as a risk-transfer tool versus [[Definition:Self-insurance | self-insurance]] or [[Definition:Captive insurance company | captive]] structures. A large corporation may choose to retain risk in-house precisely because the frictional costs of transferring that risk to the commercial market exceed the expected savings from [[Definition:Risk pooling | risk pooling]]. For [[Definition:Insurtech | insurtech]] companies, reducing friction — through automated [[Definition:Underwriting | underwriting]], straight-through [[Definition:Claims processing | claims processing]], and digital distribution — represents both a strategic mission and a core investor thesis. Every percentage point shaved from frictional cost either improves carrier profitability or can be passed to [[Definition:Policyholder | policyholders]] as lower premiums, strengthening insurance's fundamental economic case.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Expense ratio]]
* [[Definition:Combined ratio]]
* [[Definition:Loss adjustment expense (LAE)]]
* [[Definition:Self-insurance]]
* [[Definition:Captive insurance company]]
* [[Definition:Insurance value chain]]
{{Div col end}}

Definition:Frictional cost - Revision history

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