The Knot at the Bottom of the Rope

From a reader who I appreciate:

David, I am curious if you have thoughts about insurance companies (especially P&C) hedging political risk … the answer to this question obviously will carry over to healthcare quickly.

Recently, my state (Corrupticut) was hit by hurricane Sandy. Many municipalities (but not all) still had extensive flood control, hurricane gates, levies, etc from the 1970s — the last time we had really active hurricanes.

In an effort to bump up property tax revenue, several municipalities allowed developers to build McMansions right on top of, or in place of, sand dunes that had existed for centuries. The dunes blocked the view or some such nonsense. Quite predictably, these municipalities had much higher damage than those who maintained dunes and other protection.

Our idiot governor decided to keep his heel on the throats of insurance companies to make them pay — and the insurance companies called his bluff. “Fine Mr Malloy, we will stop selling home owners insurance in your state — good luck getting a mortgage without any insurance. Gee whiz, the lack of mortgages probably will devastate home prices. You should have thought of that before you chased us out.”

All up and down the coast line, insurance companies are telling state and local governments that sand dunes, levies and sea walls must be restored and maintained — or insurance will not cover anything.

States along the gulf of Mexico (ie hurricane Katrina et al) enacted laws prohibiting developers from taking down mangrove fields.

I heard rumors (not sure if they are true) that re-insurance companies have told underwriters that they will not accept pools that contain policies in states that allow destruction of natural flood barriers.

Perhaps most recently, New Jersey’s governor told his MTV “J Wow” constituents that they were going to restore sand dunes regardless of whether it looked good.

I seriously doubt that corrupt populist politicians (like the governor of my state) will stop promising to seize private property to buy votes … but it also seems they have pushed the P&C insurance industry too far. Hard to imagine that anyone will knowingly operate at a loss.

And Hugo Chavez not withstanding, most national governments won’t jeopardize their own regime to subsidize a practice that also threatens their regime.

The US government doesn’t have the trillions needed to allow FEMA to insure McMansions built where sand dunes once stood.

Whether the US ends up with “universal healthcare” or not — the federal government does not have the money to keep the current healthcare system growing 8-10% per year while the economy grows less than half as fast.

The end result is obvious — stupid government policies will fail long term. Maybe common sense will prevail again. Maybe the government will bankrupt itself and become irrelevant. Hard to guess which.

But in the short term — how can the insurance companies hedge political risk?

One of the reasons for high storm damages over the past ten years has been the pressure from developers to develop land that is beautiful, but subject to flooding risk  from storms.  In the present time, that has led insurers to raise prices on such developments, and/or refuse to insure, allowing state-sponsored captive insurers to absorb the risk on behalf of the taxpayers.

Insurers have gotten smarter, in my opinion, and most have learned to resist the actions of the states, sacrificing business volume for profitability.  They understand that there is a “Knot at the Bottom of the Rope,” below which you can’t go any lower.  So if a state is making certain classes of business unprofitable, stop underwriting those classes of business.

Contract law favors the insurers.  They can’t be compelled to take losses against their will, except by contract.

Eventually politicians have to face reality, lest they go the way of Argentina, or worse, Zimbabwe.  Insurers, though they may not be loved, reflect a fair estimation of risk.  Politicians in the short-run may try to bend the view of risk to voters, but if contract law is observed, no change will happen.

Look, we would all like Santa Claus behind us bailing out our every mistake and trouble, but in the real world, where resources are limited, claim payments flow according to contract.

Yes, the reinsurers push on the insurers, and that leads to reductions in coverage.  They have economic incentives as well, and they are all the more sharp, because they really get hit when things get bad.

Finally, you are correct that the US can’t maintain its current approach to healthcare.  If we were smart, we would eliminate the corporate tax deduction for healthcare, and return the system to the free market.  If you want health insurance, let it be done outside of the tax code.  That could help balance the budget.  As I listen to many screaming, I would add, “And let’s eliminate the interest deduction on mortgages, and the charitable donation deductions.”

We have to clean up the tax code such that most tax preferences disappear, so that the budget can balance.  Balanced budgets promote growth, because people do not fear higher future taxes.