Katrina Kompo

The Becker-Posner blog dives headfirst into turbulent waters, considering appropriate compensation for Hurricane Katrina victims. Posner argues that:

First, there should be no compensation to affluent people who could have insured against their loss, whether or not they actually bought insurance. Second, in determining compensation for uninsurable losses (or losses by people who cannot afford insurance), the amount should be determined by reference to the practices of insurance companies. Just because a person loses his house in a flood that destroys hundreds of thousands of other houses, rather than in a fire that destroys just his house, is no reason for the taxpayer to reimburse him for the loss.

Becker‘s tone is gentler, but his proposed remedy is actually harsher:

I believe it is best in deciding who merits compensation from disaster to apply to victims the same criteria used to determine who is eligible for welfare, Medicaid, and other government transfer programs. For example, families that because of Katrina lost most of their assets, became unemployed, or became sick would qualify for one or more of these programs, regardless of their circumstances before Katrina hit. Using the usual criteria that determines eligibility for welfare, medical, and other assistance, these families would automatically be helped without the need to have any special relief program.

This debate has clear consequences for Australia, where in the absence of drought insurance or a HECS-style scheme for farmers, public policy can only respond by boosting handouts to farmers when times are tough.

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7 Responses to Katrina Kompo

  1. Michael says:

    The question of government relief for “Natural Disasters” is a very interesting question. Risk is generally assessed at its return rate. Most insurance policies in Australia cover earthquake damage because the return rate is so low. There have only really been two earthquakes in Australia that have done any real damage. They are the Newcastle earthquake and the Meckering Earthquake (WA). Strangely Adelaide is the Highest Earthquake risk in Australia.

    Probably unknown to most people is that flood damage is excluded from most insurance policies in Australia. Flood has a fairly High frequency of return and the insurance industry is not will to accept this risk. So should the government make provisions to fund relief for this sort of disaster? It is not only flood but High Risk Bush Fire areas where insurance is also very difficult to obtain that should be on the drawing board for review.

    Most people will think it is not the responsibility of Government to fund for this sort of thing. Well lets turn our attention to Terrorism and Terror attacks. Do you realise that EVERY insurance policy in Australia excludes this. This despite the fact that there is no known return rate. There has been bombing in Australia The Hilton Bombing at CHOGM and attacks on the Israeli Consulate in Sydney. Now it will surprise you to find out that the Federal Government is funding for just this sort of eventuality. It has divided Australia into terror zones and levies Insurance Premiums to collect funds to compensate people who are the victim of a terror attack.

    In a country that is prone to Natural Disaster that can not be insured or the cost is prohibitive should not the government fund on an ongoing basis for all such events.

  2. Andrew Leigh says:

    Plenty of Australian companies sell flood insurance. See eg. http://moneymanager.smh.com.au/property/guides/articles/home01.html.

    That said, 5 minutes on Google does suggest that people in some part of Australia can’t get flood insurance. It’s not clear to me why this should be (the Insurance Council says that it’s because governments haven’t done enough to prevent floods, but this isn’t credible – a higher risk should merely raise the premium, not destroy the market).

    In the event of a market failure, so homeowners can’t get private flood insurance cover, I’d be quite happy for the government to chip in.

  3. Michael says:

    Andrew,

    We are now in an area of my expertise and In this case I do speak with some authority. I said in my post that flood damage is excluded from most insurance policies in Australia. This is a fact.

    You can indeed buy the coverage dependant upon its rate of return. In general the principal of insurance is about spreading risk. This would suggest that those who live in areas with a low frequency of flooding 1:100 or greater should subsidise those in high risk areas 1:50 or less. The urban sprawl and our love of living close to water places a lot of homes in areas of 1:25 or less.

    The reluctance of insurers to provide coverage has nothing to do with government and its lack of taking action and every thing to do with bottom line profits.

    The point I was trying to make is that I feel it is the responsibility of government to be proactive in funding for the sort of disasters to which Australia is exposed. If they are willing to fund for Terror attacks then they should be willing to fund for Drought and Flood.

    We do not need a ad hoc post event response we should have a proactive approach such as the Terror Levy. I have to agree that we have a public policy obligation to offer relief this however need to be balanced off against those will to take additional risk because they feel that can sell off the risk to government. Why as a matter of PP should we support people who build in a 1:10 flood frequency area? Why should we support some one who lives in a high risk bush fire area who takes no preventative measures to protect their property because a relief response exists?

    It is a delicate issue of balance with a lot of looser and very few winners.

  4. Andrew Leigh says:

    Michael, it sounds like we’re pretty much in agreement. My view is that there shouldn’t be any cross-subsidies for flood insurance (by insurers or by government). If you want to build in a high flood-risk area of Australia, you should face a high flood insurance premium, or take the risk on yourself.

    In theory, insurers should be willing to offer you actuarially fair flood insurance wherever you live. I’m still confused as to why they don’t. Can you offer any insights on this?

  5. Michael says:

    Andrew

    I had to give a bit of thought as to how to respond to your question in an easily digestible way.

    Most people wrong assume that insurance does not have any resources that are consumed in the production of an insurance policy. The truth is that the most important resource is capacity ( The allocation of the financial resources to cover the insured risk). When you consider that this is calculated as the sum total of all the insurance issued this figure for any one of the major insurers runs into the 100s’ of billions. It would go without saying that none of these companies have the capacity to pay if all these claims occurred at the same time.

    The reason they are allowed to arrange insurance at such high levels is that they buy reinsurance support. That is when a building in New Castle is insured it is covered by companies all over the world. Only a portion of it is insured in Australia. The primary insurer will keep an amount called a net retained. When disasters occour that further protect them selves with a cover called Cat Cover so that they will only have to pay the first say 50 Net Retained amounts then cover goes to the reinsurers who pay the balance.

    Australia is broken down in Cat Zones where they are given a rating. Cyclone Fire Flood Hail Wind Storm all have their own zones. A risk in the NW for example will have a Cyclone cat rating of say 5.0 where the identical risk in Backus Marsh will have a cyclone rating of 1.0.

    Reinsurers do not have the ability to look at individual risks they look at things on very much a macro level so how do they protect themselves. It goes with out saying that 1,000,000,000 worth of insurance in Darwin is a greater risk than the same amount of insurance in Backus Marsh.

    The reinsurers are at the mercy of the primary insurer so this is how it is controlled they will sell the insurer $1,000,000,000 wroth of Cat protection subject to Cat Adjustment. So $1 worth of insurance in Backus Marsh will use $1 worth of the Cat Cover. The same dollar of insurance in Darwin cost $1 * the Cat Rating in this case $5 of the available capacity is used.

    The bulk of insurance premium is in the net retained lines so in Backus Marsh you can write 5 net retained lines for every risk you do not write in Darwin.

    In the end it is a simple question of smart utilisation of the available resources. This is very mush an over simplification of the answer to your question. You have to remember that Insurance Companies have finite resources and they have to make good economic choices. The long answer to your question would take probably a few hundred pages. There are not only Cat Factors but Risk factors as well an office block with a sprinkler system installed will have a factor of 1 applied where an unprotected furniture manufacturer will have a factor of 9 applied. I think you will get a general idea of why insurance companies tend to make the choices to shy away from high hazard risk.

  6. Michael says:

    THE BRISBANE & BREMER RIVER BASIN

    We tend to think of floods as not happening very often. The above have had over 200 reportable “Flood” occourances over a 166 year history at a frequency 200:166 or every .83 of a year. Granted some are so minor as not not warrant any real consideration I just thought it might be useful for every one when considering who should pay.

    The data is here this is one of if not the worst flood risk in Australia.

    http://www.bom.gov.au/hydro/flood/qld/fld_history/brisbane_history.shtml

    Mike

  7. Andrew Leigh says:

    Michael, thanks for the explanation. So the cat zones system is administratively simple for insurers and reinsurers, but because it’s a blunt risk rating, it means that some of those in the highest category risk areas can’t buy insurance.

    (Presumably, if there was sufficient demand for insurance in those areas where people presently can’t buy insurance, then insurance companies would rejig their system to come up with something more nuanced – eg. move from a 5-category to a 10-category risk rating system.)

    Anyhow, I’m definitely with B&P – if you can’t buy insurance, the government should give you money after the event.

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