Should the government sell fire insurance?

Today, Carson and Rider assess the government’s role in fire insurance. Yesterday, they discussed the difference between local and federal response to the fires in San Diego. Monday, they pointed fingers at the city’s lack of preparedness. Later this week, they’ll debate the federal government’s disaster responsibility and development in fire-prone areas.

No to subsidies, yes to FAIRness
By Richard Carson

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.

Get government out of the insurance business
By Richard Rider

Professor Carson,

You were spot-on with your first of four principles - “Fire insurance should not be subsidized by government.” But I disagree with your second (essentially contradictory) principle that calls for continuing government insurance for existing homeowners in fire-risk areas.

Whether this insurance is provided/subsidized by government (taxpayers), or by government-mandated “insurance pools” (non-fire-risk insurance buyers), these subsidies are a bad idea, and fundamentally unfair - as you so skillfully detailed in your first principle. You are talking about a permanent subsidy to generally well-to-do homeowners - simply because they built/bought their homes in dangerous fire conditions without being told by government that they couldn’t.

Of all the things that government does, legislated risk management (primarily reflected in government insurance programs) is the one area that government almost always does wrong. Consider these examples:

Federal flood insurance encourages people to build in flood plains. Government hurricane insurance pays people to build on the coast in the path of devastating periodic storms. Government savings and loan insurance (and especially the quick raise of the per-account insurance level from $10,000 to $100,000) was the main factor in S&L over-lending and the resulting meltdown in the 1980s, which cost taxpayers scores of billions of dollars.

This government insurance problem is FAR bigger than you’d first think. For instance, the feds unwisely chose to set up the Pension Benefit Guaranty Corp., which is supposedly funded by a minuscule corporate pension fee. Now the PBGC is going broke because major corporations are realizing that their unsustainable “defined benefit” programs can be abandoned and largely turned over to the taxpayer.

Government guarantees most federal, state and local public-employee pension payout levels while under-funding the asset pools backing such pensions. This will INEVITABLY lead to a multi-TRILLION dollar shortfalls. Guess who makes up 100% of that deficit? Hint: not the tooth fairy.

Finally, let’s not forget “old-age insurance” - the “pay as you go” Social Security pyramid scheme. When the plan was founded in the 1930s, FDR supposedly insisted that it remain actuarially sound and 100% funded. That lasted about 18 months. While the plan will technically not go bankrupt, it will likely become a means-tested welfare benefit, coupled by significantly higher taxes.

Oh, did I forget to mention Medicare?

The fundamental problem with government insurance plans is that they are based on politics and “fairness,” rather than on risk levels and the commensurate required funding. Inevitably, politicians underestimate the risk and the cost.

In particular, any such government insurance program starts off without a deficit. The politicians putting the plan in place are lauded for their foresight and compassion. Later, when the Ponzi scheme collapses (or requires massive tax increases), the culprits are retired, with buildings named after them.

Professor Carson, let’s stick with your first “ironclad” principle: No fire insurance subsidies. And the only way to do that is to get the government out of the fire insurance business.

Richard Rider is chairman of San Diego Tax Fighters, a grass-roots taxpayer organization. A businessman and retired Naval Reserve commander, Rider has written dozens of ballot arguments against raising taxes and issuing municipal bonds.