Friday, June 08, 2007

Distorted Market Signals On Insurance In The Hurricane Belt

Yesterday's Wall Street Journal featured an excellent piece on the shifting burden of homeowner's insurance for those who build and live in the known or highly-probable path of hurricanes.

As I explained to my 11-year old daughter over breakfast, while we looked at the headline, when governments attempt to control the price of risk for insuring things like building vacation, or even primary, homes in the likely path of destructive weather, the tendency is for private capital to flee, and government, meaning, all of us who don't enjoy that ocean view, to subsidize those who have so built.

As the article clearly describes, the recent trend has been for states to attempt to cap insurance rates, companies to leave states, then the same states organize their own 'insurance funds,' which are, logically, inadequate to the task at hand. The ultimate guarantor, since the people in these states see fit to guarantee coverage to their coastal-dwelling denizens, is going to be Uncle Sam.

Let's review the history. The year after I was born, there was a decade-long hiatus in killer hurricanes along the Gulf and Atlantic coasts. The resulting rush to build in these hurricane alleys resulted in today's dilemma. People have been allowed to expect that they will always be given coverage, at affordable rates, for their dubious choice of location for a vacation home. Or, in some cases, primary residence.

Now that nature has returned, as it were, to the field, there's been millions of tons of toothpicks created since Hugo set down in North Carolina those many years ago. Most recently, Katrina and Rita wrecked the New Orleans and parts of the Texas, Mississippi and Louisiana coasts.

Someone must pay!

But why? Back when I began this blog, in September of 2005, I quickly wrote about who really bore the cost of location decisions in the Gulf Coast areas. Leaving aside industry, it is pretty clear that, through distorted market signals on the price of risk for homeowner insurance, too many people have built too much housing which they cannot personally afford to insure at market rates, or rebuild from their personal fortunes, in the likely path of hurricanes.

A reasonable person will see in a hot minute that the most effective solution is to reduce insurance regulation, not involve more state and Federal price signal distortion.

On a related matter, what do you think is really happening every time some Gulf Coast location is declared a "Federal disaster area?" The local residents get to rely on every other US citizen to bail them out of their choice of living in an area which may be too risky for their own wallets.

The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.

Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?

When I read in the Journal article that,

"lawmakers in some states are also facing deep public anger about the rising cost of insurance on the coast,"

I was dumbfounded. Who's fault is this? The 'rising cost' reflects reality peeking in on an otherwise state of denial.

Something's very wrong. The incentives for rational decision-making with respect to economic development is distorted. Back in the post-Katrina era, I wrote a post quoting a Holman Jenkins WSJ editorial in which he revealed that southern Senators demanded the removal of a provision in Federal flood insurance laws that put a limit on the number of times a homeowner could file claims under the insurance. They explicitly admitted that the insurance guaranteed 'economic development' by way of assuring the rebuilding of the initially dubiously-sited homes.

This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'

The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns.

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