Saturday, February 3, 2007

Can Evil Knievel Get A Free Lunch?

"The Hartford Financial Services group says it will drop about 38,000 property insurance policies in the next 18 to 30 months, about a third of its business and personal policies in the state."
http://www.palmbeachpost.com/state/content/gen/ap/FL_Hurricane_Insurance_Hartford_Financial.html?cxtype=rss&cxsvc=7&cxcat=0

How much do you think Evil Knievel, the famous daredevil, paid for life insurance at the peak of his "career"? Probably a lot if he could obtain it at all. Now would if the government intervened and put a cap on life insurance premiums in such a way that the risk of paying out to daredevils more than outweighed the profit received from the capped premiums? Wouldn't the life insurance company have to simply stop offering life insurance policies?

This is exactly what is happening in Florida today with respect to homeowners insurance.

The state has endured massive hurricane damage over the past several years. Insurance companies have paid out billions in claims. In response, they have attempted to raise insurance premiums in some cases to extremely high levels relative to what they had been.
What was the government's response? Pass a law.

Governor Crist signed a law that promised magically to reduce premiums. How? Did he allege that he has devised a method to stop hurricanes from hitting the state? No, he simply prevented insurance companies from raising premiums and forced them to "lock in" coverage through the next season.

To the extent that the government simply "caps" premiums it will result in no insurance at all as it makes for an unprofitable bet for any insurance company.

Furthermore, insurance premiums are one of the free market's defenses against irrational behavior. If you build your house on a volcano, it is unlikely anyone will insure you. To the extent that the government underwrites insurance policies that would not otherwise be offered, it encourages people to engage in risky behavior. In economic theory, this is known as "moral hazard" (http://en.wikipedia.org/wiki/Moral_hazard). (The most notorious cases are those in which homeowners continually build on ocean frontage and receive a new home from the government every time it washes away.)


The effect of Governor Crist's action as can be seen in the link above should be obvious to anyone who unlike the governor and his supporters does not believe in free lunches.

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