17 January 2007

Giving the Finger to the Invisible Hand

Granted, my enthusiasm for and faith in the free market is something akin to religious belief. I do, however, accept that not all share my faith. Notwithstanding their lack of free market faith and fervor, though, I am still left shaking my head when, more than 230 years after Adam Smith's The Wealth of Nations was published, the less-faithful cannot understand and accept the basic truths of the free market.

Begin Digression

Irrelevant but nonetheless interesting Adam Smith fact: when he was four years of age, Smith was kidnapped by gypsies.

End Digression

The State of Mississippi provides this week's free market cautionary tale. When, in the wake of Hurricane Katrina, the state government decided, for short-term political gain, to invalidate standard exclusions in insurance policies issued to businesses and homeowners within the state, the effects of that attack on settled contracts was all-too-predictable: given the increased risk associated with writing policies in Mississippi, insurers would either increase their premiums to account for that increased risk or would stop providing insurance to residents of the state. As Ted Frank of the Point of Law Forum blog reports, the latter circumstance has now come to pass:
The attack on Mississippi's insurers over Katrina is already having consequences. Unable to be confident that the state will be willing to fairly enforce contracts as written (Oct. 11, 2005; Oct. 16, 2006), insurers are simply not issuing new ones. The town of Long Beach is finding that businesses are unable to reopen because of the lack of insurance. Insurance isn't the only reason the town's largest employer, Oreck Corporation, has picked up stakes and moved to Tennessee, taking with it 500 jobs and $300,000/year in property taxes, but it's been a contributing, and perhaps the deciding, factor.

Professors Grace and Leverty over at the RiskProf blog note that the government and residents of Florida have learned a bit -- but not much more -- from Mississippi's ill-advised decision. The new governor was elected in part based upon campaign promises to lower hurricane insurance premiums:
The Orlando Sentinel (1/14) has a nice story on the problems facing Florida. They are exactly as recounted here at RiskProf over the last three years. However, they still manage to throw into the mix a quote by a (justifiably) angry, but clueless homeowner.

. . . .
"Why are they hitting us so hard?" she asked. "They shouldn't have the right to jack prices up so much."
[The homeowner], like other Floridians, want [sic] a free lunch. The governor is going to have to tax all of the citizens in Florida to keep rates lower. Where is that money going to come from? The insurer of last resort is not called Citizens for nothing!

Alternatively, a rollback in prices will generally cause insurers to leave the state. In fact, this is what caused the birth of Citizens. It has happened before and will only get worse in the future.
In Florida, for a considerable financial outlay by the state's taxpayers, the government is choosing to introduce an economically-irrational factor into the free market -- their own willingness, without business justification, to assume risk. That's their prerogative, of course; even if they've chosen to manipulate it, at least they've chosen to work within the market.

I wonder, though, how long those taxpayers who sensibly chose not to build in higher-premium areas will patiently subsidize their less-sensible fellow citizens' hurricane insurance premiums. Moreover, when it occurs to residents like the one quoted in the Sentinel article that they're not getting the free lunch they wanted, what will their reaction be?

Whichever way it occurs, when this subsidy scheme raises hackles as the premiums themselves did, will the State of Florida remember Mississippi's mistake or repeat it? Will they accept that their choice to live in a hurricane-wracked state means that the market for hurricane insurance premiums is stacked against them or will they unreasonably believe that they can change the rules of the game without any market reaction?

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