Another Example of Government Failure: Coastal Living

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."