22 Aug 2007

Government Floods

In a recent article, an area that residents' claim is unlikely to flood is set to be re-zoned as a flood plain. If that happens, residents are going to pay more for flood insurance -- if they can get it at all.

The relevant concept here is moral hazard, i.e., when people fail to protect themselves because they know the government will "save" them. In the case of flood areas, they means they under-insure. The solution is to make them buy insurance.

But what if the government decides they are in a flood area when they are not? What if they are then forced to buy insurance? Moral hazard is reversed, with the insurance companies gaining from over-insurance.

Curiously, these problems are less-relevant for fires, theft, car accidents, etc. Why? Because floods tend to affect large -- politically united -- areas. These areas unite in favor of a bail-out and politicians roll-over. This result (from public choice economics) is common in interest-group politics.

I know that the classification of flood plains is hard, but a better solution requires ALL property at sea level (+2-3 meters) to have insurance. Competition among insurers should keep premia down.

Bottom Line: When the government is on the line for flood damage, it also has the power to force insurance coverage. Two wrongs don't make a right. The government should step to higher ground.