Congress is considering disaster insurance legislation that
represents a bigger danger to the American economy than a
catastrophic hurricane season, ignoring the basic principles of how
the incentives, disincentives, and assumption of the risk in
markets really work. With the stark lesson from forty years of the
National Flood Insurance Program that subsidizing risky behavior
(building a home in a known floodplain) inevitably leads to more of
that risky behavior (rebuilding in the floodplain), creating a
similar program for hurricane zones is a very bad idea. Ultimately,
such a program might create conditions for future disasters that
make the aftermath of Katrina pale in comparison. Yet, last
November, the House passed the Homeowners' Defense Act, a bill that
would have the perverse affect of putting communities more-not
less-at risk.
Encouraging Disaster
For almost two decades, an ever increasing number of citizens
from the Midwest, Northeast, and Great Plains, seeking to escape
cold winters and economic doldrums, have flocked to the sunny
South. As those warmer states welcomed the new arrivals, more and
more of the lower Atlantic Coast and Gulf Coast became densely
populated. As densities rose, housing prices climbed, which
significantly increased the economic costs of a hurricane hit.
Rather than demanding that people who freely chose to live in
hurricane-prone locations assume responsibility for the risks of
their decisions, some states keep rates artificially low by placing
explicit or implicit rate caps on homeowners insurance or by
creating entities that serve as insurers of last resort where
high-risk homes are pooled. These subsidization schemes, in
conjunction with the disproportionate share of federal disaster
relief, distort the insurance market by undermining the assumption
of the risk accepted by the risk-taker, thereby encouraging more
risky behavior.
Quantifying Risk
Rather than push back on this trend and insist that those making
risky decisions pay the true costs of their choices, Congress is
considering a law that will perpetuate these practices. The
Homeowners' Defense Act introduces guaranteed federally backed home
insurance against disasters. In practice, however, the bill will
force all Americans to underwrite the risks of those who chose to
live in hurricane zones.
Over the last twenty-eight years, the United States has suffered
from seventy-eight billion-dollar-plus disasters. Hurricanes and
tropical storms constituted about a third of these catastrophes and
resulted in a majority of the damage-about $334 billion. The states
with the highest number of billion-dollar disasters form a crescent
starting in Maryland, swinging down through the Carolinas to
Florida and over to Texas.
While there have been billion-dollar disasters in the Midwest,
Northeast, and Great Plains, most of those disasters involved
multiple states that only in the aggregate totaled more than $1
billion. For example, the Northeast flooding in June 2006 cost just
over $1 billion but involved six states (Delaware, Maryland, New
Jersey, New York, Pennsylvania, and Virginia). The majority of
states in the Midwest, Northeast, and Great Plains suffered twelve
or fewer billion-dollar disasters. Thus, the overwhelming lion's
share of disaster claims will more than likely come from the
hurricane belt. There is a fundamental unfairness in making some
states-especially states trying to recover from the loss of
manufacturing jobs over the last twenty years-subsidize the other
states' risk for natural disasters.
Let Markets Work
Rather than continue to federalize an increasing number of
disasters, Congress should allow the insurance market to set the
proper rates in those higher risk places. In the rush to do more
harm to the insurance market, Congress continues to forget one of
the best lessons from Hurricane Katrina: despite the fact that
Hurricane Katrina was the most expensive disaster in the history of
the United States ($133.8 billion), the insurance market survived
due to the reinsurance market. In fact, in some cases, within one
year, the insurance companies were reporting sizable profits.
With the recent floods in the Midwest, another clear lesson is
that a federal program, lacking the profit and loss incentive of
the private sector, fails to ensure that risk is minimized.
Specifically, in many places, the floodplain maps are outdated and
wrong. As a result, homeowners were told they did not need flood
insurance. Due to this government failure, many homeowners are left
with no protection, which means the federal government will make
them whole with tax dollars after the fact. Because the private
sector depends on accurate information to protect profits and
minimize losses, homeowners receive protection before the event,
and the private sector is held accountable.
Finally, just like with flood insurance and Hurricane Katrina
recovery programs, Congress will continue the program even if it
goes bankrupt, forgiving loans whenever politically expediency
calls for it to do so. Once created, as has happened with most
federal programs, these programs will grow larger every year and
cover more and more routine events.
Enough Is Enough
Most states in America are relatively safe from catastrophic
natural disasters. The citizens living in those states should not
be forced to subsidize those Americans who freely choose to live in
a higher risk state. The Homeowners' Defense Act will distort the
insurance market and encourage risky behavior. Congress must stop
federalizing disasters across America and let the markets determine
the appropriate rates for homeowners insurance. Rather than
creating another massive federal program through the Homeowners'
Defense Act, Congress should adopt a different strategy: letting
the market due its job.
Matt A. Mayer is a Visiting Fellow with The Heritage
Foundation, president and chief executive officer of Provisum
Strategies LLC, and an adjunct professor at The Ohio State
University. He has served as the policy and operation counselor to
the Deputy Secretary and the head of domestic terrorism
preparedness in the U.S. Department of Homeland Security.