Another Example of Government Failure: Coastal Living

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The New York Times is reporting that the state-run Texas Windstorm Insurance Association may not have enough money to pay billions in claims from Texans whose houses and businesses were whacked by Hurricane Ike. As the Times explains:

Hurricane Ike caused as much as $16 billion in property damage, by some estimates, but the state-led insurance pool that will pay much of the cost has only $2.3 billion, leaving the Texas government on the hook potentially for billions of dollars in claims.

Insurance companies all but stopped offering hurricane coverage for property on the Gulf Coast after Hurricanes Katrina and Rita in 2005 cost them billions of dollars in claims and as property values soared, raising their exposure to disaster claims.

The pullout of commercial insurance carriers forced most property owners on the coast to turn to the state-run insurer of last resort, the Texas Windstorm Insurance Association, or the wind pool, as it is called.

Tens of thousands of owners of homes and businesses have bought storm coverage through the state insurance pool in the last few years. It now has about 225,000 policyholders, up from about 68,000 in 2001. Property in the hurricane risk zone was worth about $895 billion in 2007, an increase of 24 percent since 2004, according to the Insurance Information Institute…

Because the insurance industry had pulled out of the coastal market, an estimated 60 percent of the insurance cost in Galveston will be borne by the insurance pool.

If the "insurance" premiums charged by the state don't cover the losses, what then? Among other things, make the insurance companies pay anyway:

Insurance companies are not completely out of the picture in Galveston and the coastal counties. All carriers licensed to sell property insurance in Texas are required to participate in the state insurance pool and pay assessments based on their market share in the rest of the state. The wind pool also has rights on a $500 million state catastrophe reserve fund and reinsurance worth $1.5 billion.

These resources, plus customer premiums, have given the state insurance pool a total of $2.3 billion to cover all of this year's claims. But smaller storms this year have reduced the total to $2.1 billion.

When that money is depleted, the insurance pool can impose unlimited assessments on insurance companies. They, in turn, can recover the money through state tax breaks, spread over several years. The resulting decline in tax revenue could drain millions from the state's general revenue fund.

In a related story, the Times describes the devastation on the Bolivar peninsula across from Galveston. The Times talks with several people who rode out the storm there, including Deeann and Frank Sherman and Robert Isaacks. They are now taking certain facts into account about living on the coast:

"We take a chance living on the beach — everybody does," said Robert Isaacks, the Emergency Medical Services coordinator for Crystal Beach.

Mr. Sherman said his car repair business could not be insured because it was not elevated above ground. He tried to insure his home this year, he said, but insurers rejected the home because of the aviary the couple built out of bullet-proof glass, to protect it from storms.

The Shermans said that their life on the coast had been rich, but that it was over. They will sell their land on Bolivar to someone "younger and braver," Ms. Sherman said, and go elsewhere. "There is a passage in the Bible that says, woe be to those who live on the coast," she said. "I'm taking that to heart now."

The fact that insurance companies refused to insure property located on storm-wracked coasts is not an instance of market failure. A market failure supposedly occurs when the price of goods and services do not reflect the true costs of producing and consuming those goods and services. That's clearly not what happened here. The market is practially shouting at people, "Don't build something you can't afford to lose where hurricanes periodically crash ashore."

Instead the state "insurance" scheme is an example of government failure which occurs when a government intervention causes a more inefficient allocation of goods and resources than would occur without that intervention. In this case, it's the government that's telling people that it's OK to build in dangerous areas and then not charging them enough for the "insurance." 

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  1. But what if they REALLY want to live there? Why shouldn’t we all help them afford it?

    I love the Bible quote too. Where are all the fundamentalist leaders shouting about how the divinely inspired words of god clearly warned us about hurricanes bzttering coastlines? Oh that’s right, political correctness. Can’t insult the victims of natural disasters. Damn the religious right for pushing political correctness! Oh wait…

  2. Liberal; We need more and betterer government regulations and regulators.

    J sub D: Fuck ’em.

  3. Maybe plunking a double-wide down on the shore at Galveston is not the brightest idea. You’d think there’d be a fine market opportunity in building houses that can weather hurricanes. Maybe ones that can retract into the ground, like your balls will retract into your body when Hillary Clinton in a thong suddenly pops into your head the next time you are batin’.

  4. If the “insurance” premiums charged by the state don’t cover the losses, what then?

    I’ll give you one guess.

  5. All part of our junkie economy.

  6. Who cares, the rich can pay for it through higher taxes. It’s time to stop giving more and more to those who have the most.

    The rich don’t deserve their money. They’re suckers for working hard and becoming successful and expecting to keep the money they made.

    I’m Barack Obama, and I approved this message.

  7. Maybe plunking a double-wide down on the shore at Galveston is not the brightest idea.

    Actually it’s a better idea than what happens now.

    With the doublewide, you evacuate, the hurricane comes through, the trailer blows away, and the insurance company pays you about $50K to build a new one.

    With ‘hurricane resistant’ housing, you try to weather the storm and either get killed or have your assed saved at great cost, your house gets severely damaged and flooded out, and the insurance is on the hook for $200K + and the govt (which is the only one that does flood insurance) is on the hook for $400K +.

    It would almost be better to mandate that everyone should live in disposable houses from an economic pov.

    Also, I hate it when people use bad stats to make arguments I agree with.

    “Property in the hurricane risk zone was worth about $895 billion in 2007, an increase of 24 percent since 2004, according to the Insurance Information Institute…”

    How much of that value is the land underneath? (based on HI experience, my guess in more than half). Insurance is only paying to repair/replace the building, not the total property value

  8. “have your assed saved at great cost,”

    otoh, it may be pretty cheap to rescue Edward the Donkey; I haven’t run the numbers.

  9. I have two friends whose houses were under water when the Cedar River in Iowa had a 1,000+ year event this summer (houses outside the 500 year flood plain were inundated).

    I have mixed feelings about them. Living in a 100-year-old house in a flood plain because it’s the only affordable way for a lower income family to buy a house is not the brightest idea. But it is no where near as stupid as the well off who build resort homes on the coast where hurricanes are a 20+ year event.

    Bush was in the news today promising Texas they would get whatever they need without matching state funds. Yet the feds and the state still can’t figure out what they’re going to do with the flooded houses in Iowa.

    Well fuck Bush and fuck Texas.

  10. It would almost be better to mandate that everyone should live in disposable houses from an economic pov.

    That makes sense. But I still want a retractable house, even if it’s just for when the Mormons are in the neighborhood.

  11. Wating for the fallout…

  12. This shows more a failure of political will than a true market failure. Here’s a better definition of market failure: When needed goods or services are not provided because there is no way to make a profit on them- think health insurance for the chronically ill, or where there is difficulty charging people on an individual basis such as local roads or national defence. Finally there will always be the problem of externalities- the costs borne by others who are not direct parties to an economic transaction, another form of market failure. Libertarians often criticize others for economic illiteracy, but are sometimes guilty of it themselves.

  13. Finally there will always be the problem of externalities- the costs borne by others who are not direct parties to an economic transaction, another form of market failure.

    Externalities can be handled by Coasean bargaining.

  14. classwarior,

    1. health insurance for the chronically ill – not a market failure. There is a rate the insurance company would charge that they would make a profit, but it would be stupid to pay that rate instead of just buying your insurance directly. I dont see anything resembling market failure there.

    2. there is difficulty charging people on an individual basis such as local roads or national defence – those arent market failures. Those are, in the latter case, clear cut government services, and in the former, less clear cut but still reasonable. Libertarians arent anarchists. Anarchists are anarchists.

    3. I covered in my previous post.

  15. Living in a 100-year-old house in a flood plain …

    Flooding in Chicago this weekend. Heard a couple on the radio who bought their house 3 months ago – claimed they tried to get flood insurance when they bought the house but were told by the insurance company that they were not on a flood plain.

    Seems to me the insurance racket only sells policies to people who don’t need them – when you really need insurance, say on a hurricane-prone coast, the sane insurance business practice is to make the premium so high no one would buy the policy.

  16. 90% of what many people call market failures is actually the market succeeding in ways we dont like.

  17. robc,

    Libertarians arent anarchists. Anarchists are anarchists.

    Oh, be nice. Conflation is all they have.

    Speaking of hurricanes… did you get any damage? We only topped out around 60 mph, and just a bunch of limbs fell.

    Also, Havana Rumba off of Shelbyville Rd. had some damn fine Cuban food. (My cousin is going to UofL and I came up Saturday to see her.)

  18. With the doublewide, you evacuate, the hurricane comes through, the trailer blows away, and the insurance company pays you about $50K to build a new one.

    What would the profitable premium be on a 50K trailer in Galveston? About 8K a year? Might be better off not buying insurance at all and saving 8K a year in a CD and buying a new trailer yourself.

  19. Russ 2k,

    Makes sense when you think about what insurance is: Insurance is eliminating a big risk by spreading out the costs over a longer period of time. But, the PV of the spread out payments need to be greater than the PV of the risk for the insurance company to make money. So, any time you can afford to self insure, it makes sense to do it. If a risk is so high that the insurance companies wont sell you a policy, you shouldnt take the risk unless you can afford it.

    Which is why beach houses used to be disposable cottages.

  20. Health insurance for the terminally ill is not a market failure. Would you sell homeowners insurance to someone who’s house is on fire?

  21. Money. Money, Money, the one thing no one seems to have enough of lately. Pretty scary aint it.

    Jiff
    http://www.Privacy-Center.net

  22. SugarFree,

    When I left home this morning, I still didnt have power. My office has power today. No damage at my place, I hauled my fridge/freezer contents to my parents Sunday night. I leached a bit of ‘tricity off my neighbors generator last night. Im located 2 blocks off the prime Ryder Cup bus caravan path, so Im hoping they want those traffic lights back on really badly and my neighborhood is near the top of the priority list.

    Yesterday I came by the office to check, no power, 3 trees down in parking lot and 1 car crushed.

  23. Also, Havana Rumba off of Shelbyville Rd. had some damn fine Cuban food.

    Duh.

  24. The eye of Ike passed over my house in League City TX in the middle of the night. Just like the text books say – winds roaring out of the NE for four hours followed by worse winds from the SW for another four hours. No biggie, really; I lost a tree I loved and my fences went down. We already got our power back after only three days.

    During this event, I have seen a lot of good in people. But I am depressed. People immediately and instinctively look to various governments to help them. My own dad is looking to get a free generator and a $2500 check from FEMA because his neighborhood has a particularly bad power problem and won’t get power for weeks. You know, I might have helped him buy a generator…

    And, the subject of this article is the best example of market success there is! Prices are information, and the government destroys and mutes the information the market provides.

  25. Seems to me the insurance racket only sells policies to people who don’t need them – when you really need insurance, say on a hurricane-prone coast, the sane insurance business practice is to make the premium so high no one would buy the policy.

    People who want to build on the coastline don’t deserve insurance. That’s the whole point here.

    If state and federal flood insurance was not available and had never been available, the vast majority of homes damaged by floods in these areas would never have been built.

  26. The vast majority of the damage on Bolivar is from the 14-20 foot storm surge (water) not wind. Now, I don’t know what the legal definition of “windstorm damage” is in Texas but it sure as hell better not cover the idiots who live down in Bolivar – it’s a sea-level barrier island, for Pete’s sake. If you choose to live there (as you have the right to), you better be able to self-insure, and that’s what your insurance agent will tell you. I’m stunned to see million dollar homes there and on the West End of Galveston because, well, the beaches pretty much suck in this part of Texas anyway. Fishing shacks? Yes. Permanent homes? No way.

    FYI, I know the deductible for standard windstorm damage rider on my homeowners policy is 2% of the home’s value, so it’s only useful if my house gets flattened by a tornado, in which case I probably won’t be around to see it rebuilt.

  27. SugarFree,

    Just got home, still no power. My PC is plugged into an extension cord running to my neighbors generator. Sigh.

  28. A market failure is when a transaction that would have been advantageous to all involved does not happen or when a transaction that is disadvantageous to someone involved does happen.

    The former captures the market failure in providing public goods such as roads and defense — functions that fall upon government precisely because they are presumed to be market failures. The latter captures the market failure of externalities.

    Coasian bargaining simply transfers some of the benefits of the transaction from a party benefiting to one who is not benefiting, so that all may find the transaction advantageous.

    “Need” does not enter the picture. Not getting health insurance is not a market failure: The market worked fine.

  29. classwarrior,
    Here’s a better definition of market failure: When needed goods or services are not provided because there is no way to make a profit on them […]

    That is not market failure. If it were, then any instance of changes in tastes would be deemed a “market failure”.

    think health insurance for the chronically ill

    You are using the term “insurance” incorrectly. You insure against unpredictable events by spreading the risk among a pool of insured. The illness of a chronically ill person is a sure thing since it is happening (the risk is 100%) so it would not be moral to spread his cost over a group of people – that would be thievery. It would be like insuring your house against tornado damage when a tornado already passed over your house, passing the bill to people that have not been damaged.

    or where there is difficulty charging people on an individual basis such as local roads or national defense

    That’s not market failure. Toll roads do charge individuals. It is only because of government caprice that roads fall under their purview, not because private organizations cannot make them. “National defense” can be private – again, falls under the purview of government only because of the need of the State to defend itself from rebellion.

    Finally there will always be the problem of externalities- the costs borne by others who are not direct parties to an economic transaction, another form of market failure.

    The concept of “externality” is a dubious one, since anything one does can be defined as an externality, leading to many absurd arguments.

    Libertarians often criticize others for economic illiteracy, but are sometimes guilty of it themselves.

    Depends on the libertarians you talk to.

  30. It would make more sense to spend $10K on a used trailer if you want to live in a hurricane zone. And double-wide is a waste. You live on the coast for the scenery, not the square footage of your residence. Is having twice as much trailer worth an extra 20 grand? I’d think it would be better to bank that money. But, everyone has their reasons. Well, most people do.

  31. Same thing for people who live in earthquake and tornado zones. And don’t forget about those damn forest fires in California. Or the mudslides on the Pacific coast.

  32. According to Forbes, Texas has the highest homeowners insurance in the country. It’s almost 50% more than second place Louisiana. Hmmm… wonder why?

    So don’t feel too bad for the insurance companies… they are pricing their risk. Feel bad for the people living in El Paso who have few risks, but have to pay for the hurricanes.

  33. Jesus H Christ on a pogo stick. 30 odd posts and neither joe nor Mr Nice Guy have leaped to defend govt and chastise the free-market ideologues?

    Someone declare a state of emergency!

  34. I’ve said it before and I’ll say it again: don’t build shit you want to keep on a coastal barrier island. This precludes the entire city of Galveston, but I thought somebody would have learned this lesson after 1900. Apparently not.

  35. robc,

    Gah. Hope today turns out better.

  36. SugarFree,

    So far, nope. No biggie, Im find electricity to be overrated. 🙂 Im not going without when I get it back, however.

  37. Aw, just do what North Carolina does to keep the building boom going on the Outer Banks: make the citizens living inland subsidize the insurance of the coastal dwellers through an insurance commission and a pooled fund.

    So, even though I live 150 miles inland in a house built on an 18-inch slab poured on granite bedrock, I get to subsidize wind and flood insurance for the yuppie McMansions in Kill Devil Hills.

    Not that they are going to let me park in their driveway or anything . . .

    Anyway, there’s no such thing as a hurricane-proof house. As the great Orrin Pilkey said, all you can do is practice “damage mitigation.”

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