The recent horrendous floods in the Hunter Valley have reminded me (again) of another example of insurance market failure – flood insurance. It hasn’t hit the headlines yet, but it will.
In the Australian insurance market, it is pretty close to impossible to buy insurance against flood. Wordings vary, but basically a home and contents policy will protect you against water flowing but not rising. So if the river rises into your home, you’re not covered. If you are on a hillside and water flows through your house on its way to the river, you are covered.
I predict competing stories from Today Tonight and A Current Affair in the coming weeks, explosing those perfidious insurance companies for letting this happen.
But there is a good, sound, commercial reason. It’s pretty predictable who needs insurance against flood. I went to a presentation last year which had statistics of the costs – basically the cost of insurance for those who need it is prohibitive – at least tripling the cost of the cover for even slightly flood prone areas (unfortunately, the kind of information that insurers pay a lot of money for, so not available on the internet).
So no insurance company bothers to sell it, because those who need it wouldn’t buy it. And those who don’t need it, don’t want the insurance, so the simplest approach is for insurers not to provide the insurance. Presto! Market failure.
Some would say that this isn’t market failure – those people basically shouldn’t live in the flood prone areas if they are not willing to pay the cost. But that’s probably not a realistic answer. Most of these areas were settled many years ago. They are often poorer than average – the land was cheap, so it was used. Which is another reason why the insurance wouldn’t be bought, even if it was available.
I don’t know that there is one right answer as to how to fix the market failure. The Insurance Council of Australia is working with its members on trying to figure out a better approach. And in the meantime, government handouts and fundraising provide the only insurance available.
But its a timely reminder that the market isn’t always the answer.
Interesting, Last weekend during the wild weather I rediscovered (I’ve seen this before, but it rains so rarely I’d forgotten) that our front porch (terrace house) is a potential flood hazard. When it rains heavily and quickly, a pool of water builds up as it can’t drain away fast enough. It would only take a couple of hours of very heavy rain (like we used to get) for it to rise high enough to come in the front door. We’re probably not covered for that under our average policy. Rather than investigate our policy, I should probably try and work out how to let the water drain away more easily.
I lived in an 1837 home outside of Maitland during my last three months in Australia in 1837, and we had to cross a low wooden bridge over a creek to get into town and the railway station for transport into Newcastle for school every day. I’m wondering how my former host family is doing….
In the States, they finally gave up and now almost all flood insurance has to be bought through a government-run program. You can read up about it at http://www.floodsmart.gov/floodsmart/pages/inswhatwhy.jsp
What’s happened in many cases is that people don’t buy the insurance at all. But if they get caught up in some giant disaster, they file with FEMA and get assistance that way.
I think there may be requirements (especially if your home is mortgaged) that require flood insurance if you live in a flood-risk area. But it was obvious after Katrina that a lot of people either didn’t buy it, or that floods happen pretty often outside the flood plains, because under-insurance was rampant.