Private Flood Insurance, Tax Payer Dimes, Level Playing Fields and Petitio Principii

“Ahh, but the strawberries that's... that's where I had them. They laughed at me and made jokes but I proved beyond the shadow of a doubt and with... geometric logic... that a duplicate key to the wardroom icebox DID exist …” Captain Phillip Francis Queeg, The Caine Mutiny

Petitio Principii is the art of “begging the question.” Ah, there should be a Feast of Petitio Principii. The occasion would be celebrated widely in Washington, DC which I came to call “Capital Punishment.” Actually, even though I discovered the idea independently (you’ll have to take my word for that) the late Art Buchwald beat me to it and penned a book entitled, I Choose Capital Punishment.

Someone passed me an article this morning entitled, “Private flood insurance should be allowed to complete on a level playing field.” (https://www.rstreet.org/2017/07/07/private-flood-insurance-should-be-allowed-to-complete-on-a-level-playing-field/) I’m not trying to pick on these guys because I believe from my experience that all of Washington is busy begging some question. But I was once again reminded of the great dialogue from Downton Abbey. Someone says, “He was only trying to help!” And the dowager Countess responded, “That’s what they said about Lloyd George.”

I invite you to read the “level playing field” article. I believe the essence of the article boiled down to its nub is as follows:

Premise 1: We should have a world where flood risk is assumed by individuals in accord with the principle that a flood plain resident or business pays a price for occupancy that reflects the costs the occupant will impose and that’s the world of the private market including private flood insurance.

Premise 2: Private flood insurance will produce a world like we should want in Premise 1.

Conclusion: We should have a world with private flood insurance (which needs that cherished “level playing field” to exist) and private flood insurance will definitely produce this world we need.

It’s a wonderful argument that really assumes everything it seeks to prove.

First let’s look at Premise 2 because it’s by no means universally accepted that private flood insurance will even be provided by the market let alone produce the same results we believe free exchange would produce in the case of a commodity like corn (the private market principle is most honored in the breach). I don’t want to dwell on details in this piece but I do want people to know that for many decades a not insignificant group of competent economists has taught that the market will fail to produce flood insurance because adverse selection precludes such an outcome. Now there are data that suggest some people are buying private sector flood insurance for expensive homes that have values that exceed the coverage these people could buy under the government National Flood Insurance Program (NFIP). These are wealthy people. If you’re interested in adverse selection and the feasibility of a private flood insurance market, please look at the literature. I don’t want to mire down in this one point. But I do note that the government got involved in the current NFIP because the market was not offering flood insurance in the voluntary exchange setting of the market. Some argue things have changed.

Premise 1 is more troublesome and I want to discuss it briefly. Do we really want the world that the author of the paper advocates in Premise 1? Presumably that’s a world with optimal flood insurance prices and the internalization of the costs of flood plain occupancy (at least as regards buildings and contents) to the prospective occupants. Theoretical normative economics can be used to say that’s an efficient world and I am not questioning the conditions for economic efficiency. There are various ways to state the optimal pricing conditions but I believe the idea of prices reflecting incremental costs suffices to get at what the author of this paper had in mind. I tried during my life to study a little economics. If we price flood plain occupancy in this way, we ought not to be spending “government dimes” on buildings and contents either. All well and good. One should note that we could arrive at these principles without ever talking about private market flood insurance. It’s an open empirical question whether market flood insurance could get us to efficiency Nirvana if we decided we wanted to go there. And there would be losers as well as winners although the winners might be able to bribe the losers to take the trip.

But the argument goes too far in assuming that there’s no social purpose being pursued in the pricing and cost sharing inherent in the current government flood insurance (NFIP). I don’t believe I’m obligated to make argue the case for alternative values to point out the question begging in the author’s argument. But those who are thoughtful about the facts of our existence can look at the reasons the government has intervened in the health insurance market and find many of the same motivations that are likely to apply in the case of flood insurance. One reason is likely the adverse selection I alluded to before in discussing Premise 2. Another is a concern for the ability of prospective policy holders to pay for insurance. Perhaps we look at a state like Louisiana and conclude that Louisiana IS a flood plain much in the same way California IS an earthquake zone.  If people are going to live in such places and produce things the rest of us want, it’s not unlikely that the rest of us will share in the extra costs of living in those kinds of hazard zones and sometimes the government will coerce us to do the sharing and at other times these added hazard costs will end up in the market prices of the goods we consume from Louisiana and California.

My point is that the system of subsidized flood insurance we have (which is starkly different than the author’s desired world) may have been erected for some social purposes that aren’t completely in alignment with the author’s ideas of what the world ought to be in terms of fairness. I’m not faulting the author for having a different point of view but the force of his argument for the old “level playing field” sans “government dime” is little more than an expression of his sense of social purpose. It’s not geometric logic. 

The usual course of normative economic theory is to seek the optimal pricing structure and then ask what institutions might achieve those conditions. In this case government provided insurance might provide for those prices if we eliminated the subsidies and perhaps better than the market which is plagued with adverse selection. But the market certainly ought to be considered. 

But I conclude that we have no consensus for Premise 1.  As a people we have been trying to do something different than the author merely assumes as desirable. 

As a related aside, perhaps one of the biggest disservices of na?ve market advocacy in this case is the idea that you can use flood insurance, say the NFIP, to internalize the all the costs of flood plain occupancy. Not so fast. The NFIP payout during Katrina and Rita was $17.1 billion. The value of FEMA Disaster Relief Funding was another $82 billion (not covered by insurance). The Corps of Engineers spent something like $15 billion on flood infrastructure after the storm. It would be silly to try to run the NFIP to internalize all the costs of flood plain occupancy. We need to study and understand the world a little better. See J. David Cummins, Michael Suher, and George Zanjani, “Federal Financial Exposure to Natural Catastrophe Risk, National Bureau of Economic Research (https://www.nber.org/chapters/c3036). Note this from the paper: “The $82 billion in emergency federal spending on Katrina and other proximate hurricanes in 2005 exceeded the fiscal year (FY) 2005 budget of all but five government agencies, as well as the total amount appropriated for the much maligned Congressional earmarks.”

We should have a conversation about the role of private insurance but I believe we can’t finish that up until we decide what kind of sharing of the benefits and costs of flood plain occupancy we as a nation want. We have to address rather than beg the Premise 1 question. Our Good Samaritan behavior is at odds with the author’s begged question.

With the usual apologies to the PoliSci majors, thanks for listening.