Saturday, September 10, 2005

Paying for Katrina

Sorry, but I have been away from the blog for a few days. The news about Katrina has dominated just about every media channel in the past couple of weeks. There is much to comment about in the aftermath of this disaster. It has brought out the best and worst dimensions of the human condition. Though I hesitate to focus on the negative, a story in last Thursday's Wall Street Journal struck a chord with me that merits comment. (Paying for Flood Damage Looms as Big Challenge, p. 1, September 8, 2005)

This article reported on the conflicts between insurers and their insureds over hurricane-related damage. Most homeowners policies don't cover damage from floods. Earthquakes are usually out too, unless you agree otherwise. The significance of this point occurred to me one evening while watching coverage of the hurricane. In the midst of a water-filled neighborhood, one home was burning. That homeowner didn't realize it, but he might call himself lucky, as this may be a way to have coverage for losses that might otherwise have been his alone to bear.

There are sound reasons for these exclusions. If your home burns or is struck by a tornado, the scope of damage is usually not so widespread as to pose a catastrophic loss to the insurer that would threaten its viability. Private insurance companies can handle spreading out these day-to-day risks quite well. However, floods have long raised problems because of the extent of the devastation and the potential exposure to loss. For this reason, the federal government helps to take on risks associated with floods through a national flood insurance program. (I hope to include commentary from a good friend who is an expert on flood insurance in a future blog, but as you can imagine, he's up to his eyeballs in flood-related issues right now.)

If you don't pay for flood insurance, then, you don't get coverage. It can be expensive, and I imagine it was expensive indeed for someone living below sea level. However, that's part of the cost of living near water. If people choose not to pay others to assume that risk, then it falls to them personally. Of course, the federal government may intervene here to help out in times like this, but that is another matter. The point is that the insurer didn't assume this risk for those who did not pay for coverage.

However, as reported in the WSJ, a trial attorney in Mississippi has suggested another approach. He is urging the Mississippi Attorney General to take the position that flood exclusion provisions in homeowner policies are "unconscionable" and against public policy. However, that is a terrible idea for all of us. Without a predictable scope of coverage, the insurer has a hard time pricing the risks being assumed. If the risk could be increased by judicial fiat, then I suppose the rational insurer would price that risk into the policy, too. And that would mean higher premiums for all of us.

Instead, I suppose, we will see higher federal expenditures to pay for these uninsured risks. This raises some interesting equity issues concerning the prudent ants and the imprudent grasshoppers. There will be time to discuss that later, though, after people have stopped smarting from the pain inflicted by this disaster.



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