#TBT "Insurance can be a very strange game"

Today's throwback is to a column Nancy wrote in the fall of 2006 in the Mississippi Business Journal. Her topic? Insurance in the wake of a catastrophic hurricane.

I hate insurance. It feels like wasted money. You pay in big, fat premiums, in hopes you'll never have to use it. Of course, if the worst happens, you face a company who isn't too thrilled about letting go of their money. It's a strange game.

Insurance is all about risk management. Premiums for a 16 year old male driver are horrendous, but the odds of that 16 year old wrecking the family car are extremely high; in fact, some would say it's a given. The company must cover its costs. Premiums for property coverage in Biloxi are also high. Any property owner in a hurricane-prone area can expect to pay through the nose for someone else taking the risk of damage.

The insurance business is a business. These guys aren't in charity work, so you must concede profits. They want a big enough pool of customers paying a big enough premium to cover any losses and still leave them with cash in their pockets. Otherwise, why bother?

But, there are a few complications here. Catastrophic events can wipe out a company, and that is exactly what happened after Hurricane Katrina. Some companies folded or left the state or dug in their heels about payouts. Even reinsurance (insurance for insurance companies) has dried up after last year's hurricane season. Many companies have stopped allowing new property and casualty policies, and local insurance agents are scurrying to find a new way to make a living.

The complaint on the consumer side is, "Yeah, but look at all the years when I paid in, and you didn't pay out." There were 30 years between Camille and Katrina when the insurance guys were making money hand over fist. Now, when their services are needed, they are nowhere in sight. Did the execs spend too much of the premium money, such that the money just wasn't there to cover the big events? If so, I think they need to fire the actuaries.

Then there are the theorists, those guys in their ivory towers spouting, "Let them eat cake." According to Adam Smith's invisible hand, if no one shows up to offer affordable insurance, the risks are too great, and development should fade away. The federal government should not subsidize insurance. It's a distortion of the free market system. According to the purists, only the mosquitoes should live in Biloxi.

Risk and rewards

But I'm a finance person. Risks and rewards go together. Before we toss out the baby with the seawater, consider the benefits of coastal development. Take a look at the coast of Alabama just two years after Hurricane Ivan. It's booming. With the growth of the baby boom generation and its excess disposable income, this trend will only continue. The last time we were in Orange Beach, we noted the number of grandparents with grandchildren in tow. Talk about some serious cash being dropped. Coastal areas are gold mines. To walk away from their development because of the high risk of storms is to ignore the high rewards they offer during calm seas.

So, how do you encourage reasonable development, but still allow the insurance companies to make a profit? At the risk of incurring the wrath of my academic friends, I think the National Flood Insurance Program is a step in the right direction, but it needs to be revamped. The maps are outdated and should be revisited on a regular basis. Stringent building codes within subsidized areas should be enforced. Insurance companies should be allowed to make profits, but not windfalls. States should consider additional subsidies in prime areas to encourage development. The highest risk areas should be populated by those people and companies which can weather a catastrophe. Vacation homes, resorts and larger retail establishments are better suited for this.

Delicate balance

After Katrina, everyone was screaming about discouraging development in hurricane-prone areas, but just two weeks before, they were thrilled about coastal development. The problem is that it's fairly easy to measure the cost of a storm like Katrina, but how do you measure the cost of not developing your coastline? Storms come with the territory, and it's just a matter of risk management. We should not be surprised when there is another Katrina. We should be prepared.

So, while I hate insurance, I understand the delicate balance between this beast and the growth of an area. If insurance dries up, the area will dry up. For now, I'm just glad I don't have a 16 year old boy to insure!

--Nancy Lottridge Anderson, Ph.D., CFA, Mississippi Business Journal, August 21 - 27, 2006

#uncertainty #insurance

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