Different Responses to the Same Exposure to Risk

This story is from last week, but it’s too useful to ignore:

As the wildfires that ravaged Southern California for five days lost momentum yesterday, representatives of the insurance industry said the estimated $1 billion in fire damage would have little if any impact on homeowners’ rates in California or the rest of the nation.

“It’s well within the range of losses we expect to see in California every few years,” said economist Robert Hartwig, president of the Insurance Information Institute. “That means the rate in this area is already reflected with the risk associated with wildfires.”

Private businesses have an incentive to plan for the possibility that risk will turn into reality. This should not shock anyone, yet we constantly hear calls for government interference. Generally it’s because people are too immature to pay the full cost of their risky decisions, but the next line of the article offers another complaint.

After Hurricane Katrina and the Florida hurricanes in 2004 and 2005, insurance premiums in the Gulf area and parts of Florida doubled over three years, according to institute records. When 2006 turned out to be relatively hurricane-free, the higher premiums contributed to record insurance-industry profits.

Nowhere in the article does it indicate the likelihood those “record” profits will be later offset by record losses if another Hurricane Katrina occurs. Nor is there mention that the chance of such extreme devastation occurring again is increased by the political insistence on subsidizing the higher risk of living in an area like New Orleans to avoid asking some voters to pay for their own life choices.