My Talk on Insurance

I gave a talk on my idea of using insurance companies to monitor water managers for operating efficiency and/or capital expenditures at my department (Agricultural and Resource Economics @ UC Berkeley) just recently.

Here are the slides [PDF] and here is the audio [17 MB MP3] of the 50 minute talk.

The main points that came out were the importance of having enough companies competing for enough contracts so that they can calculate accurate actuarial risks (weighted probability of rationing, spills, etc. across policies for many water agencies) and the importance of disclosing the insurance premium to water customers who will want to know how well their managers "stack up" against other managers at other agencies. This latter point is important because water agencies are monopolies that face little competition. Since insurance companies will be competing for business, they introduce the helpful dynamics of competition where none now exists.

Insurance is not currently required of water companies that self-insure, but that situation is not useful to the extent that:

• Water managers may self-insure in varying degrees that cannot be compared;
• Managers who preside over accidents merely increase water rates AFTER the fact to pay for their mistakes; and
• Regulators (CPUC over investor-owned utilities and politicians over municipal utilities) almost ALWAYS ratify these ex-post rate increases because they can see that a disaster happened and money is required.

That last point is important: Most water managers have no incentive to operate efficiently because they do not benefit if they do extra work, and they can always get money to fix problems if/when they happen. Further, they face pressure to keep rates low and raise rates if/when disasters happen, so we get a disaster-rate increase cycle that is disruptive (even tragic) and inefficient. Insurance companies would reduce those cycles by collecting money up front to cover disasters that happen later (rates will NOT rise by as much b/c the insurance companies will pay for the clean-up). Finally, the mere presence of insurance companies will improve efficiency everywhere, by making it "profitable" (lower premia) to improve operations.

Bottom Line: It's hard to regulate monopolies (like water agencies) because of asymmetric information (managers know more than we do) and the problem of free-riding (an individual's cost of monitoring operations are greater than his benefits). We can avoid both these problems by "outsourcing" monitoring and competition to insurance companies.