From Practical Economics
Insurance as a form of investment serves an important part in maintaining efficiencies in the market. Unfortunately, insurance is not limited to the private sector where competition and fear of losses force insurers to act in effective, productive and efficient ways or go out of business. Public or government run insurance programs have a record of inefficiencies that is remarkable. This is due to the fact that the mechanisms of the market, most notably competition and the profit/loss motive, do not apply to public insurance programs. Without fear of losses and competition from rival companies, public insurance programs are doomed to be wasteful, ineffective and inefficient.
Public insurance is risk blind, meaning it takes on risks that otherwise would not be insured by private companies unless extremely high premiums are paid. This allows for inefficient decisions to be made. Public insurance also charges premiums that are far below what the market equilibrium would demand. This creates incentives for individuals to take risks (and assume more services) they otherwise would avoid with the government (taxpayers) picking up the tab. Public insurance allows people, that otherwise could not afford to take on the risk or pay market premiums, to build on the beach or in high fire risk areas. This is a recipe for inefficiency and a waste of scarce resources.
Another pitfall of government insurance, or the presumed safety net of government policy, is the concept of moral hazard, or when a person or group is sheltered from risk. Moral hazards create incentives where individuals act in ways contrary to the risks that would be taken if the costs were fully carried by the individual. As a result, moral hazards create market inefficiencies/failures. The private insurance sector can create moral hazards, but is less of a problem as premiums and incentives adjust in relation to the amount of reckless behavior taken by policy holders. In the public sector, however, no such constraints exist.
A good example would be the moral hazard created by semi-private Fannie Mae and Freddie Mac insuring sub prime mortgages. This created a situation where lenders offered mortgages to people who did not have the credit to take on high risk debt. They did so because they were sheltered from carrying the risk burden by the government. This moral hazard eventually created severe market failure in the credit and banking industries.
In short, the free market protects against moral hazard, while government sponsored enterprise fosters its creation. Protecting losses that are far too risky to insure in the first place is an inefficient use of capital. Examples of public insurance programs run by the federal government include: flood, mortgage, bank deposit, terrorist acts, war risk, children‘s health, unemployment, life, pension, dental, vision, and crop insurance. In addition, Medicaid, Medicare, and Social Security are also federal insurance programs. The shear number of public insurance agencies found under the government banner is inconsistent with the spirit of capitalism and the free market.