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The 'Ill Wind' of Government Policy
By Jeffrey J. Pompe As Texans continue to repair the damage from Hurricane Ike, Southeastern U.S. coastal residents can be thankful that the hurricane season is past its peak. Unfortunately, given the increased hurricane activity in recent years and the combination of densely populated areas, high-valued property, and vulnerability to extreme storm activity, the likelihood of future costly seasons is a certainty. The scenes of hurricane disasters have become too familiar for Southeastern coastal residents in recent years. The 2004 and 2005 hurricane seasons, for example, produced seven of the ten costliest insured losses ever to impact the United States; all seven hurricanes struck the Southeastern coast. In order to curtail such disasters, the combination of natural events and human activities that is responsible for the increasingly costly damage in coastal areas must be altered. Although we can’t force a hurricane from its path, we can modify human activities that contribute to such disasters—beginning with government policy. The federal government encourages development in hazard-prone coastal areas by lowering the risks to residents with policies such as subsidized flood insurance. The National Flood Insurance Program (NFIP) charges premiums that are not sufficient to provide a catastrophe reserve for heavier loss years and thus encourages development in hazard-prone areas. When the NFIP was began in 1968, it was intended to guide development away from flood-prone areas, thus reducing federal disaster relief payments arising from loss of life and property. Unfortunately, the program, which has become an “ill wind that blows nobody any good,” promotes the outcome it was meant to prevent by shifting part of the cost of building in hazard-prone areas to citizens at large. Ordinarily, individuals respond to the rising costs associated with storm damage by moving out of harm’s way, if ever so reluctantly. Governmental policy thus increases damage costs from storms by neutralizing the market incentives that encourage a retreat from the sea and discourage excessive building in high risk coastal zones. In addition, state government policies subvert the message of insurance premiums. Wind damage caused by hurricanes (which is not covered by the NFIP) has imposed heavy costs on insurance companies, thus causing insurance premiums to increase. As coastal residents have seen their wind and hail insurance premiums soar, state governments have been pressured to intervene. All Southeastern state governments have created state-run Windstorm Underwriters Associations, called “wind pools,” that offer coverage where private insurance is not available and generally at lower rates than provided by individual insurers. In addition, there are other government policies, such as beach nourishment and the replacement of public infrastructure, that subsidize coastal development. A better approach is to allow market signals such as insurance premiums to encourage property owners to undertake activities to adapt to living in a hazardous area or to avoid building in such areas altogether. As insurance companies increase property insurance premiums in order to pay for increasing damage costs, homeowners will increasingly build more storm resistant homes and look for less risky locations. Market forces can help lower damage costs from hurricanes, but because many do not like the solution, government is brought into play in an effort to soften the cost impact. Calls for more government “solutions” should be carefully considered, given some of the deleterious effects of policies currently in place. When government undercuts private insurance rates, it weakens the market incentives that encourage preventive measures and sends the wrong signal to coastal residents. Indeed, despite the increasing threat of catastrophic storms, residents often rebuild in the same place where their destroyed property had been located. Rather than encouraging people to build in hazard-prone areas, government policy should play a secondary role in dealing with the problem, allowing the market to nudge individuals in the right direction. The misery of those struck by hurricanes is unfortunate, but government policy should not encourage decision-making that contributes to their suffering or shifts costs to those who do not live in the path of “ill winds.”
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