Insure us all

Busy, busy, busy of late. It'll probably continue for another couple of weeks -- until finals wrap up. In the meantime, ...

I'm commented before on insurance markets. In case you've never thought about it, insurance is designed to spread the risk of catastrophe over large numbers of people. You pay a "small" premium to protect you from the "large" consequence should the dreaded event occur. You pay in because you know you just might need it yourself one day -- though you probably won't. If insurance was a "good buy" (I interpret that as meaning you get back at least what you pay) for everyone, then no insurance fund could ever remain solvent.

What sparked this primer on basic insurance? A column in USA Today on "price gouging" in the insurance industry. Now I will admit that collusive activities and attempts to fix prices are possible in the insurance industry, but Al Neuharth (the founder of USA Today) never presents any evidence of such activity. No he just wants to rail against the evil insurance companies who are ripping off homeowners in disaster-prone areas:

The hurricane season officially ends today. Despite dire predictions from forecasters last spring, the USA was virtually unhit for the second straight year, with only one minor Category 1 hit in Texas.

But millions of coastal homeowners from Florida to New York continue to get heavy hits from insurance companies.

Rocky Scott, public information officer for Florida's Citizens Property Insurance Corp., provides this perspective:


* Since Hurricane Katrina in 2005, some private hurricane insurers have raised rates in coastal states by as much as 300%.


* Even state-sponsored Citizens Property Insurance, based in Florida, has increased premiums by up to 150%.

Insurance company rip-offs aren't limited to hurricanes. Homeowners hit by other weather catastrophes — blizzards, earthquakes, floods, tornadoes — often get similar shocks.

So let me see if I understand Mr. Neuharth's reasoning. After a couple of years of huge payouts to homeowners affected by hurricanes, insurance companies are raising rates A LOT. Despite the accusations of price gouging, there are a few other explanations. Yes, it could be that the insurers are taking advantage of homeowners -- given the limited number of "big players" in the insurance industry, I'd say the degree of true competition is limited. On the other hand, it could be that insurers are now realizing the expected payoff on a hurricane-prone home is a lot higher than they thought. What would be the rational response? A rate increase seems logical in that context.

Now I'm not saying 300% increases are appropriate. I'm also not saying they're not. I don't know. I just think it's a little silly to immediately accuse the insurance companies of malfeasance without evidence. I do know (or at least I've heard from friends with knowledge) that many companies have simply stopped insuring homes on the AL coast. If, as Mr Neuharth claims, hurricane homes represent a cash cow for insurance companies, why would companies be fleeing the market?

Regardless, Neuharth offers a solution:

Former Florida insurance commissioner Tom Gallagher advocated a federal catastrophe insurance program financed by premiums nationwide to help pay for weather-related disasters anywhere across the USA.

[...]

I'm all for free enterprise. Usually when politicians step in with things like price-wage controls, it's a mistake. But as a longtime beachfront homeowner, I'm reluctantly convinced the federal government must intervene to rein in insurance gougers. Skyrocketing premiums are a bigger threat to more homeowners than the variable-rate mortgage foreclosures.

First, it always scares me when someone starts a sentence with a phrase like, "I'm all for free enterprise." Just as "I'm not a racist," "I'm all for free trade," and "It's not that she's a woman," sometimes make me suspect the speaker may be a racist, isolationist woman-hater, "I'm all for free enterprise," makes me think Mr. Neuharth is about to show he is not, in fact, in favor of free enterprise.

Second, after reading the rest of the paragraph I don't see any reason he'd be against free enterprise. He admits government imposed price controls usually (his word) are a mistake, but he gives no evidence for why they would NOT be a mistake in this case. Wait; he does. I see it now. "But as a longtime beachfront homeowner ..." I suspect that's what has made Mr. Neuharth abandon his free enterprise principles in this instance.

Third, think of the logical implications of this whole argument. If insurers truly are engaged in collusive behavior to expropriate monopoly profits from homeowners, then there is a case for government intervention. Even Mr. Neuharth, though, points out that Florida's "state-sponsored" insurance fund increased premiums by up to (another phrase I abhor in arguments) 150%. It seems to me the insurance market may be sending a basic economic lesson to "longtime beachfront homeowners": Your desired behavior is costly. If you want to engage in it, you'd better be ready to pony up some jack. The result? Fewer people would build houses on the beach. Those that did would be wealthy enough to pay the premiums or replace their homes on their own. That may seem unfair, but is there an inherent right for Everyman to be able to afford a beach house?

So how about the alternative? What would a national "weather-related disaster insurance fund" do? Well first it would insulate homeowners from paying the full cost of their behavior. It would NOT, however, reduce the cost of rebuilding homes and businesses (over and over for some locations) after hurricanes. It would just spread that cost over more and more people. Who are these people? Us. All of us. American taxpayers. Well at least it would keep beachfront property ownership more egalitarian, right? Nope. Yes, some "common" folks can afford beach property right now, but what happens to the desirability of that property if hurricane insurance becomes a lot cheaper? The property becomes much more attractive and the price of the property will be bid up by, I suspect, an amount roughly equivalent to the "savings" from the insurance program.

So what would we end up with? I suspect it'd look a whole lot like the government-sponsored flood insurance program. It's a bit dated, but John Stossel once did a really nice job on that program. [If you've never seen it, it's well worth reading.]