Common Tragedies

Thoughts on Environmental Economics

Adapting moral hazard

Posted by Danny Morris on April 21, 2009

Insurance is going to play a huge role in getting policymakers and the public in general to get a tangible grip on the effects climate change will have on our daily lives. I’ve blathered blogged previously about some of the interesting moves that state regulators are making to force the insurance industry to be more transparent in how it classifies threats posed by climate change, but don’t think they have it all figured out either.

Last Friday, ClimateWire posted a fascinating little ditty on the current battle in the state insurance regulator world about a national catastophe plan. The issue at hand is whether or not the federal government should accept the risk from increases from swirlier hurricanes, twistier tornadoes, blowier winds, and other incredibly technically-termed problems. This could prove to be a boon for states like Florida, which could rely on the other 49 states if this year’s hurricane season is particularly nasty.

Florida could use a little help, especially with its state-backed Citizens Property Insurance Corp., which has up to $45450 billion in exposure and about $3 billion to cover it all. For those of you math-challenged, that is 0.67 percent of total exposure that Florida can cover, and non-Floridians can cover the rest. This of course is in lieu of private insurance, which is retreating from coastal Florida faster than a gale force wind.

The regulators haven’t approved the plan yet, not are they anywhere near doing so. Despite the reprieve, there are still reasons to be concorned. While there is not much we can do about existing infrastructure in at-risk areas, we should still reflect the actual risk we face in different areas with insurance premiums.

I know this is radical idea, but I promise I’m not out on this limb all by myself. Howard Kunreuther, an expert in risk management, said the same thing two years ago in a far-more reputable publication than this one. Not reflecting real risk in really risky areas is what we in the business call ex post moral hazard. As climate changes manifests itself in nasty ways, what with the sea level rise and all, we are going to face this type of moral hazard more and more, and we’ll have to decide how to deal with it. Hopefully, it works out better than the last one.

Full article after the jump.

INSURANCE: State regulators repeatedly clash on national plan for catastrophes (04/17/2009)

Evan Lehmann, E&E reporter

Divided insurance regulators abandoned plans yesterday to vote on an embattled document outlining methods of federally backing up insurance companies during calamitous storms associated with climate change.

The move came after a dozen state regulators, from diverse areas of the country, clashed over a white paper that seems to endorse the controversial idea that the federal government should accept the riskiest elements posed by more powerful hurricanes, frequent tornadoes and earthquakes.

Critics contend that states like Florida — which one regulator chided as being “broke” — are forcefully pushing the document because they have the most to gain from a national plan that could provide coastal states with financial help from the Midwest and other inland areas.

But other regulators, including Illinois’ insurance commissioner, Michael McRaith, say it’s urgent that the outline be finished so lawmakers can use it to draft protective policies in a time of greater peril. Several coastal states are seeing insurance companies retreat from the seashore or raise premiums as they struggle to gauge the impacts from a warming atmosphere.

“While Hurricane Katrina was devastating, catastrophe modelers have identified a number of possible natural disasters that would dwarf the damages caused by this event,” the 29-page white paper warns.

McRaith took the helm of the troubled outline this year, when he was named chairman of the National Association of Insurance Commissioners’ Property and Casualty Committee. But he inherits a process that is beset with conflicting opinions in an industry that, in economic terms, is one of the nation’s largest. The paper has been slogging through contentious proceedings for more than two years, and it has been rewritten 14 times.

“Is there a desire to now create a 15th version of this paper?” McRaith asked his counterparts near the end of a disputatious conference call in which a vote was scheduled to be held.

Several regulators answered yes.

180 degrees in the wrong direction

The divide, in simplest terms, separates regulators who feel that private insurers should cover increasing risks — even if that means charging higher premiums — from those who believe that affordably priced premiums in a national plan could offset staggering emergency funding that the federal government is bound to pay anyway after a colossal event, like Hurricane Katrina in 2005.

“An approach that utilizes a federal reinsurance program seems to be the most economical solution,” the paper says.

But that angers some regulators, who believe that if lawmakers oversee an insurance program, they would be politically driven to set inexpensive rates that fail to consider the true costs of living within punching range of stronger hurricanes and bigger storm surges.

That, in turn, could encourage more development along the coastlines, putting more people at risk and increasing exposure to loss.

“In my opinion, this white paper is endorsing something that is just totally 180 degrees from where I think we should be going,” said Scott Richardson, the insurance commissioner of South Carolina.

He said his state has increased premiums for wind coverage — the riskiest kind — by 35 percent and purchased expensive private reinsurance to protect the state’s finances if a big storm blows ashore.

“What I see in this paper is the beginnings of just saying, ‘Well, you really don’t have to do that,’” he added.

David Conrad, a water resources specialist with the National Wildlife Federation, compared a future public program to the 40-year-old National Flood Insurance Program, which provides subsidized rates to about 20,000 communities. The program went bankrupt after the 2005 hurricane season and is currently $19.2 billion in debt, Conrad said.

“The Congress, I’m afraid, tended to use the program as more of a constituent service than as a risk management program,” he said. “Many of the regulations tended to, in the long run, be developed as how to build in the floodplain [rather than] how to avoid it.”

Still, others appear eager to help those states most at risk.

We all need to help

Morris Chavez, New Mexico’s insurance regulator, admits that his state faces fewer risks than coastal states. But he’s willing to see premiums and taxes in New Mexico rise to accommodate those hazard-prone states.

“Look at how climate change has affected not only the United States, but the world,” he said in an interview, pointing to hurricanes, tornadoes and other risks. “We would be fools not to believe that the future’s only going to hold the same type of weather patterns, if not worse.”

“It’s something we have to think of globally,” he added. “I’d like to think that when New Mexico has problems, there’s going to be insurance commissioners, regulators or even policyholders from other states that say, ‘Hey, let’s do what we can to help one another.’”

McRaith delayed a vote on the white paper until June, when commissioners meet in Minneapolis for their summer meeting. He asked regulators to submit new ideas for confronting risk, but warned that they should leave their “arguments” at home.

The decision comes at a critical time for Florida, which is seeking a line of credit from the Federal Reserve to buttress its faltering state-run reinsurance fund as hurricane season looms. The public fund backs up a state-operated insurance company, Citizens Property Insurance Corp., which has about $450 billion in exposure, and about $3 billion in surplus to pay claims.

Florida lawmakers in Congress have introduced the Homeowners’ Defense Act, which would allow states to pool their resources in the event of a big storm. They could issue bonds to finance their own reinsurance programs, and if that failed, the federal government could step in with cheap loans.

Critics of the white paper believe the document endorses the legislation, which they say could turn into a politically driven tool to bail out Florida and other risk-prone states. The paper itself, they say, could be used in Congress to generate support for the legislation.

But McRaith says the paper is only intended as a reference tool for policymakers, who could use it to see a broad range of approaches for developing a national catastrophe plan.

“There’s nothing in this report that endorses any specific approach,” he said, warning regulators that they need to find consensus soon. Otherwise, he said, the paper will linger in limbo “until the cows come home.”

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One Response to “Adapting moral hazard”

  1. dWj said

    Just for the math-challenged, would you care to run those numbers again, paying special attention to decimal point placement? Thanks.

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