One problem that insurance companies face is moral hazard - where one of the parties to an agreement has an incentive, after the agreement is made, to act differently than they would have acted without the agreement and bring additional benefits to themselves, and to the expense of the other party. Moral hazard is a problem of 'post-contractual opportunism'. The moral hazard problem in insurance occurs because the insured party passes some of the risk of their actions onto the insurance company, so the insured party has less incentive to act carefully. For example, a car owner won't be as concerned about keeping their car secure if they face no risk of loss in the case of the car being stolen.
Similar effects are at play in home insurance. A person without home insurance will be very careful about keeping their house safe, including where possible, lowering disaster risk. They will avoid building a house on an active fault line, or on an erosion-prone clifftop, for example. In contrast, a person with home insurance has less incentive to avoid these risks [*], because much of the cost of a disaster would be borne by the insurance company.
Unfortunately, there are limited options available to deal with moral hazard in insurance. Of the four main ways of dealing with moral hazard generally (better monitoring, efficiency wages, performance-based pay, and delayed payment), only better monitoring is really applicable in the case of home insurance. That would mean the insurance company closely monitoring homeowners to make sure they aren't acting in a risky way. However, that isn't going to work in the case of disaster insurance. Instead, insurance companies tend to try to shift some of the risk back onto the insured party through insurance excesses (the amount that the loss must exceed before the insurance company is liable to pay anything to the insured - this is essentially the amount that the insured party must contribute towards any insurance claim).
And that brings me to this article from the New Zealand Herald from a couple of weeks ago:
Thousands of seaside homes around New Zealand could face soaring insurance premiums - or even have some cover pulled altogether - within 15 years.
That's the stark warning from a major new report assessing how insurers might be forced to confront the nation's increasing exposure to rising seas - sparking pleas for urgent Government action.
Nationally, about 450,000 homes that currently sit within a kilometre of the coast are likely to be hit by a combination of sea level rise and more frequent and intense storms under climate change...
The report, published through the Government-funded Deep South Challenge, looked at the risk for around 10,000 homes in Auckland, Wellington, Christchurch and Dunedin that lie in one-in-100-year coastal flood zones.
That risk is expected to increase quickly.
In Wellington, only another 10cm of sea level rise - expected by 2040 - could push up the probability of a flood five-fold - making it a one-in-20-year event.
International experience and indications from New Zealand's insurance industry suggest companies start pulling out of insuring properties when disasters like floods become one-in-50-year events.
By the time that exposure has risen to one-in-20-year occurrences, the cost of insurance premiums and excesses will have climbed sharply - if insurance could be renewed at all.
Because insurance companies have few options for dealing with moral hazard associated with disaster risk, their only feasible option is to increase insurance excesses, and pass more of the risk back onto the insured. Increasing the insurance premium also reflects the higher risk nature of the insurance contract. Even then, in some cases it is better for the insurance company to withdraw cover entirely from houses with the highest disaster risk.
I'm very glad that the Deep South report and the New Zealand Herald article avoided the trap of recommending that the government step in to provide affordable insurance, or subsidise insurance premiums for high-risk properties. That would simply make the moral hazard problem worse. Homeowners (and builders/developers) need the appropriate incentives related to building homes in the highest risk areas. Reducing the risk to homeowners (and buyers) by subsidising their insurance creates an incentive for more houses to be built in high-risk locations. However, as the New Zealand Herald article notes:
Meanwhile, homeowners were still choosing to buy, develop and renovate coastal property, and new houses were being built in climate-risky locations, said the report's lead author, Dr Belinda Storey of Climate Sigma.
"People tend to be very good at ignoring low-probability events.
"This has been noticed internationally, even when there is significant risk facing a property.
"Although these events, such as flooding, are devastating, the low probability makes people think they're a long way off."
Storey felt that market signals weren't enough to effect change - and the Government could play a bigger role informing homeowners of risk.
Being unable to insure one of these properties creates a pretty strong disincentive to buying or building them. Perhaps withdrawal of insurance cover isn't a problem, it's the solution to a problem?
*****
[*] Importantly, the homeowner with insurance doesn't face no incentive to avoid disaster risk, because while the loss of the home and contents may be covered by insurance, there is still a risk of loss of life, injury, etc. in the case of a disaster, and they will want to reduce that risk.
No comments:
Post a Comment