Katrina remedies?

What are the options?  I don’t buy the Leeson-Sobel notion that cutting FEMA aid will improve long-term performance in disaster-stricken areas.  The real question is what we should do ex ante.

Howard Kunreuther and Mark Pauly promote a traditional idea:

This paper explores options for programs to be put in place prior to a
disaster to avoid large and often poorly-managed expenditures following
a catastrophe and to provide appropriate protection against the risk of
those large losses which do occur.  The lack of interest in insurance
protection and mitigation by property owners and by public sector
agencies prior to a disaster often creates major problems following a
catastrophic event for victims and the government.  Property owners who
suffer severe damage may not have the financial resources easily at
hand to rebuild their property and hence will demand relief.  The
government is then likely to respond with costly but poorly targeted
disaster assistance.  To avoid these large and often uneven ex post
expenditures, we consider the option of mandatory comprehensive private
disaster insurance with risk based rates.  It may be more efficient to
have an ex ante public program to ensure coverage of catastrophic
losses and to subsidize low income residents who cannot afford coverage
rather than the current largely ex post public disaster relief program.

The goal is to make people internalize the social costs of placing their assets in a vulnerable position.  If you own a home by a questionable levee, you have to buy insurance.  Maybe the price of that insurance will tell you not to keep the home.  I have two problems with this idea.  First, in distributional terms we will essentially end up confiscating the homes of many poor people.  Second, insurers can be notoriously reluctant to write policies for high-risk areas, or they will write policies with exorbitant non-expected-utility-based rates.  (Is any of this regulatory?  Why don’t the markets pool out the risk?  Is there a principal-agent issue within the insurance company?)  It might lead to far more confiscation or abandonment than is efficient.

The correct ex ante policies toward disasters remain an underexplored are of microeconomics.  And why private insurance doesn’t do a better job of insuring against long-run risks..well…that is perhaps the leading question of applied microeconomics today.

Here is my previous post on libertarian policy recommendations and Katrina.

Comments

do i sense a business opportunity in lon-term insurance here? to be fait, berkshire hathway does do long
term insurance.

Insurance companies are also
notoriously reluctant to pay claims
following disasters (their advertising
not withstanding). Absent some provisions
requiring relatively rapid settlement
of claims, even appropriately-priced
insurance provides no guarantee that
people suffering catastrophic damage
will be compensated.

And, by the way, I thought Tyler's
argument was that insurance companies
are offering insurance with higher-than-
"correct" rates.

First of all from a libertarian stand point...If you build your house by a levee and you don't have any kind of insurance you are basically self insuring. This principle is similar to increasing a deductible from $500 to $1000. If you take on the responsibility of the first thousand dollars you are self insuring and if a disaster strikes you owe the first $1000. Also, if you build your house next to a levee no one should have to be forced to buy insurance. This similar to being forced to buy health insurance, whether I want to or not. The other problem is that the government continues to subsidies people who choose to live next to a levee. They never learn a lesson. "I don't have to worry, the government is there to take care of me, even though I know the dangers."

There was a program that talked about the New Orleans levee and there was a "levee expert" on the show. His statement caught me off guard. It's not a matter of how much a levee can hold til it breaks its a matter of when it will break. He said point blank that no levee system in the world is perfect, the Dutch haven't even come up with a levee that will hold back every break. If the government continues to subsidize people living next to a levee because the poor schmucks lost their house, why not keep living there.

Secondly, in response to Bernard's last line. Competition does keep this from happening. But the law must be willing to enforce contracts. The dispute in the Katrina area is over language, "wind blown vs flood". This makes a big difference in claims, because it is contractual. Regulation on insurance limits the number of insurers within the markert. Let's say an insurance company gets a poor rap for bad claims service, it has several options, either improve service or get out of that line altogether. Auto insurance may be a little easier to understand. If someone runs into my car and I don't believe my insurance company is handling the claim well, what am I likely to do? Go to another company that better claims. It behooves the insurance company to provide great claims service. In a catastrophe there are limited resources, even for big bad insurance companies. (Don't come back with I am insurnace company apologist, I just live in the real world.) The issues never get wiped away, but it can certainly hurt an insurance company's bottom line. There are good companies and bad companies. Eventually the companies that provide great service will be better off.

Auto industry is another good example of how good and reliable service benefits companies. If I can limit who has the ability of competition to get into the market, then I can continue to provide crappy service.

Sure state insurance comissioners can do what they want, but I don't want to go too much into the Iron Triangles.

Bernard makes excellent points. To assume the mostly poor and undereducated residents of the lower ninth worth exhibit the rationalty of homo economicus is ridiculous. Hence this point by Matt, "First of all from a libertarian stand point...If you build your house by a levee and you don't have any kind of insurance you are basically self insuring." is true but ultimately unproductive.

Matt also says: "The other problem is that the government continues to subsidies people who choose to live next to a levee. They never learn a lesson."

Christopher says:
"If we're going to subsidize poor decisionmakers, let's do so in a way that we don't have to do it again at some point in the future. Give current home-owners a one-time housing voucher. If they then decide to build there anyway, make them pay high mandatory insurance rates sufficient to cover the risk. "

I direct them to this article by John Stossel raises questions about the rationality (at least of the rich) to build in vulnerable areas.

Finally, the primary insurer in the NOLA area is State Farm which had inadequate reinsurance to respond to a major disaster like Katrina. Much like FEMA, insureres were not prepared to respond to a major disaster.

the events are sufficiently rare that you don't have the opportunity to test them out until it's too late

Right, but you don't learn just from your own case, you learn from others. Insurance companies develop a reputation. And the more successful an insurance company is, the more data there is on them, and the more you know how they deal with ever rarer cases.

There is also a possible setup: let an intermediary decide whether the payment is merited, rather than letting them be a judge in their own case. Private courts. Much cheaper and quicker than public courts. Such market innovation is curtailed by government interference, and government does interfere in insurance. Lesson: more laissez-faire, please.

if everybody were dissatisfied after Katrina and everybody switched, but the companies saw no net change in their number of customers

The same argument would apply equally well to any competitive market. If all providers of X (anything - maybe pizza) were equally bad, and if all customers switched leaving the pizza sellers on net no worse off than before, then pizza sellers would (so goes the argument) not learn anything. But obviously, that's not how it works at all. Your scenario is at best a statistical unlikelihood on the order of all the molecules of a gas in a room spontaneously moving to one side of the room, which technically they can do.

Bernard makes excellent points.

Bernard's points appear to be made in ignorance of economics. He seems to think that economists fail to take into account what he is saying, but the reality is that they do take it into account and he fails to take into account what they are saying. Specifically, he treats the points that he raises as if they were intrinsic properties of the insurance business, where any economist can easily see how these aspects of the insurance business can be expected to arise out of unhealthy economic processes - possibly market failure, but more likely government interference. Matt explains some of this. Bernard is describing outcomes as if they were inputs to an economic model.

To assume the mostly poor and undereducated residents of the lower ninth worth exhibit the rationalty of homo economicus is ridiculous.

Expressions of contempt for the poor, such as the above, are no substitute for argumentation.

Bernard's points appear to be made in ignorance of economics.

Constant,

You have already established in previous comments that you are an arrogant asshole. No need to provide further evidence.

Your points seem to made out of ignorance of how the world works, and unthinking devotion to libertarian dogma.

Insurance companies develop a reputation.

Reputation effects. The last refuge of libertarian theology.

he treats the points that he raises as if they were intrinsic properties of the insurance business, where any economist can easily see how these aspects of the insurance business can be expected to arise out of unhealthy economic processes - possibly market failure

As a matter of fact insurance companies by and large prefer not to pay. That seems like an intrinsic feature to me. If that doesn't fit into your wonderfully clean and abstract and utterly sophomoric view of economic processes, too bad. Though I do give you credit for conceding that there is some slim possibility of market failure.

Bernard is describing outcomes as if they were inputs to an economic model.

I am describing incentives and bargaining relationships that ought to considered when trying to understand the process, because they have important effects on the outcomes. Those lovely graphs in chapter one don't exactly tell the whole tale.

Private courts - right. That'll equalize things. Faster? Why? Do you think there will just be all these private judges, etc., just waiting around for the disaster? Cheaper? Why? And what about fairness? Who will pick these private judges?

Expressions of contempt for the poor, such as the above, are no substitute for argumentation.

Neither is misrepresenting others' meanings, something you are quite fond of.

Bernard writes: "As a matter of fact insurance companies by and large prefer not to pay. That seems like an intrinsic feature to me. If that doesn't fit into your wonderfully clean and abstract and utterly sophomoric view of economic processes, too bad."

But in fact I am perfectly aware that if they can at all get away with it, insurance companies invariably will choose not to pay. Ask Tyler Cowen, ask Matt, ask anyone you're targeting with your remarks whether they are aware that businessmen would screw the customer if they could get away with it, and I am sure that they would all respond that they are perfectly aware of this and take it into account in their thinking. And for you to believe otherwise, for you to believe the nonsense that you are stating, only shows that you truly do not understand what they are saying and why. You think you are telling them something they do not already know, but in fact you're only revealing what you do not know.

There are are many issues, but one of the most basic ones seems not to even have been mentioned -- if you live next to a levy, your concern is that the levy might break and your house might flood. But private insurance companies do not write flood insurance coverage. The federal government does.

Moreover, at least as it constituted currently, the National Flood Insurance Program's existing mandates that those who live in 100-year flood plains and have federally regulated loans must purchase flood cover generally does not apply to those communities that are protected by levies. In point of fact, one of the greatest forces that drives communities to BUILD levies in the first place is to be freed of the mandatory purchase requirements.

"And why private insurance doesn't do a better job of insuring against long-run risks..well...that is perhaps the leading question of applied microeconomics today.
"

Really? It seems like one that has a pretty simple answer -- because current tax and accounting laws do not allow insurers to reserve for potential catastrophic risks, and current state rate regulation regimes do not allow insurers to price for potential catastrophic risks.

People living in the ninth ward (not to mention NOLA and LA in general) lag behind national measures of formal education. These are facts.

I did some quick googling and found this site:
http://www.dollarsandsense.org/archives/2006/0306wagneredwards.html

According to this site, 40% of the people in the ninth ward lack a high school diploma, 29% only have a HS diploma/GED, and 7% have at least a Bachelor's degree. If nearly 2/5 of the population did not even finish HS, I seriously doubt they have the level of education (though they are probably capable of it) to act as economically rational as the people in Stossel's article. Furthermore, even highly educated people often do not make decisons that maximize utility. I think I remember reading this in Thaler's "The Winner's Curse". Isn't the concept of "bounded rationality" a tenant of behavioral economics? I freely admit I lack the background in economics of Prof. Cowen and certainly Constant. However, I fail to understand how merely mentioning the the undereducation of the 9th ward populace implies I have contempt for the poor. I am merely pointing out they lack the economic education of Constant Economicus. And this lack of education has to play some role in their economic decision making.

If nearly 2/5 of the population did not even finish HS, I seriously doubt they have the level of education (though they are probably capable of it) to act as economically rational as the people in Stossel's article.

So let's subsidize economic and personal-finance education. Or are you suggesting that the government can second-guess everyone's economic decisions?

Irving - Behaving rationally given the incentives does not require a high school diploma, nor does it require even average intelligence. As Matt points out, the people we are discussing do in fact appear to be acting rationally given the incentives they are presented with. Therefore, there seems to be no call to consider them to be irrational.

Moreover I would argue that the conclusions from the assumption of rationality are robust. Given a large population, only some of them need to be rational in order to produce outcomes very similar to the outcomes that a perfectly rational population would produce. consider the length of the the lines at two checkout counters. Suppose that the two lines are equally fast. Then if only half of the population chooses the fastest (i.e. shortest) line and the other half chooses a line randomly, then the lines will still stay about the same length most of the time. For simplicity's sake, suppose that, first, six people choose their line randomly, and then six more people choose the shortest line. Even in the worst case scenario, if all the random choosers choose one line so that one line has six people and the other line has zero, then the rational choosers will all choose the other line, so that in the end the lines will be of equal length. This is a simple demonstration of why it is not necessary for more than a fraction of the population to be rational.

We can can construct similar examples to illustrate that perfect rationality is also not required. Suppose that each person has a split personality and chooses rationally only half the time. Again, the outcome will be two lines of about equal length - close to what we would expect if everyone were perfectly rational all the time.

In California, earthquake insurance is administered by the state for the most part. It has the unpleasant properties of being both extremely expensive and having a high deductible (>10% of the value of the home).

I am not aware of any supplemental insurance market to cover this enormous deductible: this suggests that there is a moral hazard problem in this market. The result is that many, if not most, at-risk homeowners do not carry insurance at all. They are no doubt expecting some kind of government bailout should a major earthquake happen. And there is little doubt in my mind that such a bailout would happen. The most recent big earthquake -- Northridge -- caused $44 billion in damage. A major quake in the Bay Area would easily be more than that.

Forcing people in coastal California to buy earthquake insurance would undoubtedly lower premiums a bit -- it would also increase the exodus to other parts of the country. The main problem is that in a modern democracy, it is very difficult if not impossible for the government to make a credible commitment to not bail people out.

Simple solution:

When FEMA pays you the value of your house from the flood insurance program, the property should go to the government, just as a totalled car becomes the property of the insurance company. Turn the flood zone into a big park or something, rather than paying people off and then letting them keep the land and rebuild on it.

Note that this escapes the trap of eminent domain. First, the flood victims are being offered not merely the actual value of their houses at the time of the transfer, but the insured value _before_ the transfer, which is necessarily much greater. And second, the transfer could be made voluntary. Want to keep your land? Fine...but no FEMA payment for you.

From the point of view of an insured individual, this is a less attractive program, since it dispenses with the "FREE MONEY!" aspect of the current FEMA policy. But as a taxpayer, I'd like it a lot better.

It offers the additional advantage that, since the payments would still be available (on the added condition of giving up a then-worthless piece of property and moving elsewhere to build) there would be no images of disaster-imposed poverty with which the leftists could hammer the change, and hence it could be made a stable part of the policy.

Moreover, since the maximum value the NFIP will insure is $250,000, even a "total loss" scenario won't actually cover even the full market value of the house, much less than land. This is particularly true of those properties most at risk of total losses -- beachfront homes in hurricane-prone areas.

insurance cars

We talk about insurance companies taking out reinsurance. I wonder: is there a market for reinsurance on the part of consumers? You take out an insurance policy on whether the insurance company you hire will pay off its obligations; who better to fight the insurance company or to understand the fine print. I'm only half kidding.

In the event some disaster occurs, the financial institution hopes that somehow they will have their bases covered and will not have loans outstanding to untold thousands (or maybe millions) of homeowners who have had their properties wiped out

This would be true IF those same financial institutions actually KEPT the loans they originate. Invariably, this is not the case. The loans are quickly sold off into the secondary market, where they are shuffled around, subject to credit swaps, broken up into derivative pieces, and collateralized in capital markets across the world. So, while the originating institution is usually about checking the security of the loan and that it is adequately insured, there isn't a very good record of follow-up. I guess the secondary market players just tend to feel they are so well-diversified and have so many hedges in place that they can't be bothered with the legwork of checking up on insurance renewals.

I just stumbled onto this, and it is a very interesting debate. I grew up very close to the Ninth Ward, and maybe can share some insight:

The Ninth Ward IS a poverty-stricken area, unlike their neighbors to the east, St. Bernard Parish (completely decimated). Most homes are hand-me-downs or owned by elderly residents. It was a mix as to if they were insured, but the pre-Katrina value of most homes was around 50-60k.

You fine folks assume that because the area was flooded, it was flood prone. ABSOLUTELY NOT TRUE. I challenge the original author's use of the phrase "questionable levee." The Ninth Ward and St. Bernard have been flooded twice before Katrina: First, when the Industrial Canal was intentionally broken in 1927, and then when the levee broke after Hurricane Betsy and the creation of the MR-GO in 1965. As a person who lived in the area after Betsy, we were told repeatedly that the levees had been reinforced and pumping capabilities beefed up. We were safe. Insurance prices bore this out. There had been no significant increases in homeowner premiums for years.

This is the point I want to make: this disaster had little to do with the unaltered topography of the area getting inundated with water and more to do with manmade structures that CHANNELED water into dry areas. It was caused, almost entirely, by the poor designs of the ACOE. Water was channeled up the MR-GO to the Industrial Canal, as well as through Lake Ponchartrain and down the adjacent canals in Lake View. The ACOE had begun two reports many years before on this possibility but abandoned them when information was leaked out about the poor designs. We were kept in the dark.

Citizens have fought the MR-GO for years (just google it) and were getting nowhere. The federal government went to the mat to keep it open while it eroded and gobbled up thousands of acres of barrier wetlands that would have protected us. It original intent was as a short-cut to New Orleans ports, but it was rarely used. Still, taxpayers spent billions keeping it open and fighting the lawsuits.

The houses in the area pre-dated that monster, so the arguement about not building in dangerous areas can be tossed out the window. Safe areas were made unsafe by manmade structures that were poorly designed. Personally, I feel as if the federal government caused this mess, and won't lift a finger to prevent it from happening again.

So, if it wasn't a "flood" where water rises up, but rather channeled water that was DIRECTED into the heart of the city and dumped, who pays? I can assure you, the payouts that I have heard about are minimal. I know of no one who has received LRA funds. Most folks are abandoning their homes or rebuilding by hand (I have helped rebuild a relative's home this way).

If you don't know, here's the best part of this story: the new FEMA flood advisories have been adopted by much of the metro area. They require most areas such as St. Bernard and the lower Ninth Ward to raise their houses by 3-4 feet. Insurance costs are based on these advisories, and if you don't raise your house, you can lose coverage or pay penalties. The average water in these areas was 12-20 feet (my relative got 14). The average cost to raise a house was around 100k.

To add insult to injury, the latest report shows that the MR-GO is eroding again, washing away the temporary repairs made to it. The ACOE says they may get around to armoring it by 2010.

You folks can debate who should pay the insurance costs, but in the end the insurance companies have cut and run. Who can blame them? The feds can't seem to fix the problems they created, and keep handing it back over to the ACOE - the wonderful engineers who created the mess. Seems to me that if the MR-GO was closed, the cost of levee armoring would be reduced, the city would be safer, and the insurance companies wouldn't face risk. But that just makes sense.

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