Should the government sell fire insurance?

Richard,

Sen. Dianne Feinstein (D-Calif.) is planning to hold hearings on California's fire insurance in the aftermath of the recent fires. There should be four guiding principles for policymakers thinking about insurance issues.

The first is ironclad: Fire insurance should not be subsidized by the government.

Subsidies help to increase building in fire-prone areas. Existing homeowners who would gain from more subsidized fire insurance are likely to be much wealthier than the average Californian. Real estate developers would be the other major beneficiary, because subsidies of this sort are quickly capitalized into land prices.

The second principle is that fire insurance needs to be available to homes that were already built before the current round of fires.

Mortgage lenders generally require fire insurance as a condition of loans they have already made. Much of the concern about fire insurance is driven by homeowner fear of policies being canceled and not being able to get insurance. The long-standing solution to this market failure is the state of California being the insurer of last resort. This can be done directly, as California chose to do with earthquake insurance, or indirectly by requiring companies selling property insurance in the state to participate in a pooling arrangement that offers insurance to homeowners unable to obtain it through regular market channels.

This is what California (followed by most other states) decided to do back in 1968 after the Watts riots left an insurance vacuum in parts of Los Angeles. This program is known as the California FAIR plan. No doubt there are problems with the plan, ranging from a website that doesn't work with pop-up blockers to the always present concern of whether these pools are run in an actuarially neutral manner, or whether underwriting is appropriately sensitive to differences in fire risks.

The third principle is that California needs to decide quickly whether it wants to make new properties built in high fire-risk areas eligible for the California FAIR Plan.

Making them ineligible is a heavy hammer, but one that could be used, because government at all levels incurs an obligation to protect these homes from fire after they are built. From a pure insurance perspective, though, as long as no cross-subsidy between these properties and existing lower-risk ones exists, there is no reason to deny eligibility. On a related note, the government might want to insist on disclosure of the California FAIR Plan's rate for a property being sold, along with the other disclosures now required.

The fourth principle is that communities need to take action to reduce the risk of wildfires to their citizens, and those citizens need to take action to reduce their own risk and the risk to their neighbors.

This should be reflected in insurance rates and made more transparent. Given the inevitable need for the state of California and the federal government to jump into any large-scale wildfire, they have a legitimate interest in thinking about how to best protect communities.

>Richard Carson is an environmental and natural resource economist at the University of California, San Diego, where he studies natural disasters, among other things.

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Professor Carson,