Whose Disaster Is It?

No one wants to pay for natural disasters. But even small-government proponents may have to accept increased federal involvement.
December 2017
Just 15 percent of Houston homeowners had federal flood insurance before Hurricane Harvey hit. (AP Photo/David Goldman)
Donald F. Kettl
By Donald F. Kettl  |  Columnist
Former dean of the School of Public Policy at the University of Maryland, and a nonresident senior fellow at the Volcker Alliance and the Brookings Institution

With its pink sands and warm water, Bermuda is a great place to visit. It’s also a great place to live. It has the fourth-highest per capita income in the world. But that’s not because of tourism.

It is because of reinsurance, the arcane business of selling insurance to insurance companies. We buy coverage to protect ourselves from really big losses, and the insurance companies do the same -- they buy policies from reinsurance companies to defend their bottom lines from disasters much like this year’s hurricanes. Low tax rates attract many of these reinsurance companies to havens such as Bermuda. It’s the big reinsurers, like PartnerRe, Everest Re, Ace and XL, that float much of Bermuda’s economy.

But hurricanes are a huge nightmare for these companies. As Hurricane Harvey showed this year, a single big storm can drown whole neighborhoods and cause tens of billions of dollars in damage. Economists have argued for years that the best way to manage such risks is for the government to identify neighborhoods that are prone to flooding, create zoning laws that restrict construction in these areas and encourage everyone else to buy flood insurance.

First-line insurance companies are very queasy about this approach. Big storms such as Harvey, Irma and Maria can put the companies -- financially speaking -- underwater. That’s where the reinsurers might be expected to come in. They are the masters of disaster, selling policies to other insurance companies to protect against mega-losses. But it turns out reinsurance companies don’t much like flood insurance either, because the potential for sudden, large-scale losses is so great.

The federal government has its own flood insurance program, and that constitutes a major line of defense when the reinsurers back away. Most citizens in hurricane-prone regions, however, don’t take advantage of this federal coverage. Fewer than half of all Florida residents have purchased federal flood insurance. In Houston, it’s just 15 percent, and in Puerto Rico, 1 percent. 

Some citizens simply don’t have the money to buy insurance. Some are caught up in the “it won’t happen to me” syndrome. And some, perhaps, assume that the government will sweep in to provide relief if they’re ever hurt, even if they didn’t buy protection. 

So the combination of reinsurance and federal coverage isn’t enough to solve the problem. That realization led Florida to step in with its own state-run insurance program. The program has boosted the number of Sunshine State residents with flood insurance, but critics complain that the state coverage is too expensive, and conservatives grumble that it’s a socialist takeover of private markets. Meanwhile, the program’s supporters argue that it’s ultimately the state that ends up protecting residents who are abandoned by private insurance companies and who fail to buy federal policies. 

Florida’s program weathered Irma’s fury, but the state was lucky because of the storm’s last-minute zigs and zags. Had the hurricane hit Florida with the impact that forecasters initially feared, the losses might have collapsed the state insurance program entirely.

All of this is generating a huge debate about who ought to be responsible for what in the world of natural disasters. What should we do when private companies back off from selling policies where they might suffer big losses -- and when the reinsurance companies get nervous about backstopping the industry? What should we do about a federal flood insurance program that people won’t pay for, even though they should? And what should we do about state-based programs that can be wiped out with a single big storm?

One could argue that the federal government is inevitably the insurer of last resort. When a catastrophic flood occurs, everyone tends to look to the feds to provide help -- even those who refused to buy federal flood insurance. That, in turn, triggers another puzzle. When the federal government does provide aid, should it forbid homeowners from rebuilding in harm’s way?

This brings the economists back into the debate. The private insurance option is surely the most efficient answer to the dilemma: Define the risks, allow people to make their choices, encourage them to buy coverage, and do relatively little for those who refuse to buy the insurance and then lose their homes. But like many solutions that economists favor, this one may be politically unfeasible. The political costs of allowing the uninsured to suffer are probably too great. And beyond the politics, the strategy would require stabilizing the private insurance market, especially convincing the reinsurers to take the risk that comes with the potential of more Harvey-Irma-Maria hurricane seasons.

That’s a tall order. With the likelihood of more big storms, a private insurance industry struggling to cope and state-based programs likely to be swamped -- the odds are that even fans of small government will have to accept increased involvement on the part of Washington. 

Everyone wants protection from mega-storms, but no one really wants to spend money to get it. And no one wants to be told that they can’t build wherever they want to. These dilemmas are pushing the policy debate away from private market solutions and more toward a federal strategy where taxpayers foot the bill -- and where we struggle over national decisions about local land use. It’s no wonder that the Bermuda reinsurers would rather spend their time enjoying the island’s pink sands than struggling with these tough dilemmas.