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Insurance is a difficult business in the presence of moral hazard. While an insurance company can make a profit by exploiting the risk aversion of its policy holders, this profit may be annihilated if moral hazard drives the insured to increase the risk. And if policies cannot discriminate by risk category, then only bad risks can be insured, at a loss. But I do not see where there could be moral hazard in the case of hurricane insurance, as policy holders cannot influence the path of a hurricane. If they fail to strengthen their house, this is something that is easy to inspect and price into a policy. So why did private insurance companies leave the hurricane insurance market in Florida?
Mario Jametti and Thomas von Ungern-Sternberg describe how the state of Florida had to step in and provide coverage to all homeowners at a cost ultimately much lower than what private companies offered. While the state may be able to better diversify over the area of the whole state, it is not like it does not face substantial risk. A hurricane can have severe consequences for a significant part of the state. Private companies can diversify with other geographic areas or coverage types, they can even re-insure, two means that are not available to the state. But the latter can make up any loss with federal help or, gulp, taxes. And it cannot simply declare bankruptcy if it takes a big hit, like a poorly covered insurance company would.
Friday, September 25, 2009
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3 comments:
But I do not see where there could be moral hazard in the case of hurricane insurance, as policy holders cannot influence the path of a hurricane.
Arguably building on or adjacent to Florida beachfronts, or in very low level areas such as the Ninth Ward of New Orleans, or in the Outer Banks or Florida Keys, involves moral hazard if the insurance rates are subsidized by policy holders or taxpayers in lower risk areas.
But not if this risk is priced in the policy, which is easy to do as it is clearly observable.
I would guess that the implied answer to your question about private companies is that the risk in general is not fully priced into the government policy, and that on a practical basis the political tendency regarding differential risk based on location on government-sponsored insurance is that very high rates on at-risk property would meet more organized resistance than more moderately higher premiums across the board, which would imply inlanders would subsidize coastal folks. For the first, it wold be useful to compare time-weights on insurance payouts for elected officials and insurance boards.
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