I read part of an article in Property & Casualty Insurance News (December 24/31, 2007), the “Top 10 Stories of 2007.” The California wildfires are number 10 on the list.
Iin the wake of other mega-catastrophes like hurricane Katrina, the bad publicity surrounding the CA wildfires doesn’t help the reputation that insurers have. Who knows, someday we might even see a class-action suit against P&C insurers in California, exceeding the $3 Quadrillion settlement demanded by some of the Katrina victims.
I will take a brief moment to remind my readers that insuring against some of these perils, in certain locations, is actuarially impossible. People respond to incentives. This much is elementary. Legislation however, often with large subsidies, has been crafted in defiance of the laws of probability and economics in order to combat the problem of people who want to have their cakes and eat them, too. The end result is a moral hazard of epic proportions, and one which is to an extent, self-reinforcing. Also, it’s communism.
Anyways, when legislation perverts the incentives in such a manner as to transfer the risks associated with certain geographies*, the laws of economics take hold: when behavior is subsidized, we get more of it. The increased demand causes either the construction of more homes in the risky locations, or raises the market values of existing homes. Or both.
These factors exacerbate the losses incurred by disasters like hurricanes and wildfires.
To the point, the article cites a contributing factor: a large number of underinsured homes, citing an 11/13 NYT article reporting that nearly 40 percent of California homeowners lack adequate (replacement cost) coverage. The industry of course, “rejects the notion that large number of underinsured homes is their fault.” Some go so far as to call such a notion “a figment of… political imagination.”
The article cites “failure to report improvements to the insurance company” as the principle cause of underinsurance. Aside from the fact that most people, in most places, are simply idiots when it comes to their financial security, I think that government manipulation of the market has been a contributing factor, as well. In some of the fire-prone counties in California, property values doubled in the 5 or 6 years prior. If the value of your property rises, and you do not have a guaranteed replacement cost policy, you’ll quickly find yourself up Shit Creek, sans paddle, when you try to file a claim. And it does not matter whether the property increases in value because of improvements you’ve made, or because of inflation. The latter is arguably more difficult for the lay person to recognize as a problem.
The moral hazard created by the regulatory agencies is, to be sure, part of the problem. Excessively loose monetary policy, which caused the run-up in housing prices and the mortgage bubble and the current “economic downturn,” was simply (no pun intended) adding fuel to the fire.