Saturday, September 16, 2006

Flood Insurance Reform

How flood insurance tempts the rich (HT: BizzyBlog via email) takes a look at the unintended consequences of flood insurance.

Congress is working on the Flood Insurance Reform and Modernization Act of 2006, which follows several 'tweakings' of the original 1968 National Flood Insurance Act which include:

(Backgrounders: history of flood insurance and significant floods since 1978.)

Many have advocated Rethinking Flood Insurance. True reform would get government (and ultimately politics) totally out of the flood insurance business. So argues, Dwight M. Jaffee in his commentary for The Federal Reserve Bank of St. Louis Review:

...I firmly agree the first best solution is to keep the government out of the insurance business entirely, or to retire the government from active duty as soon as practical after a major event...

Not convinced by the arguments of an MIT trained and now Berkeley-based economics professor? How about the arguments of two recent Nobel prize winners:

...Thanks to this new emphasis on a bottom-up, or microeconomic, approach, Mr Kydland and Mr Prescott were able to craft their most enduring work. In a paper in 1977, they demonstrated the importance of credibility in economic policy. If governments cannot commit themselves credibly to a course, their policies may be futile.

Examples abound, showing the wide applicability of their work. A government might, for instance, want to discourage building in areas prone to hurricanes. So it warns citizens that no compensation will be given for houses in such areas should disaster strike. If people believe the warning, they will not build. But if they expect (as history suggests they should) that the government is likely to soften its stance and pay for hurricane damage after all, they will ignore the warning. Before the fact, the government wants to stop building; afterwards, it wants to compensate those who have suffered. Mr Kydland and Mr Prescott refer to such conundrums as “time consistency problems”...

If someone wants to develop in a flood prone area, do so at your own risk. Otherwise, Taxpayers Get Soaked by Government's Flood Insurance. In an effort to protect everything, we actaully end up protecting nothing.



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