Saturday, March 08, 2008
Insanity
People don’t talk much these days about nationalizing industries. When they do, it’s usually in an underhanded and roundabout way, as if nationalization is a bad word. Universal health care, for example. We’re talking about nationalizing a HUGE part of the economy. Government expenditures are already 30% of GDP, and now we’re talking about bring another 8% of GDP directly under the purview of the government, in one fell swoop. So government will be responsible for nearly half of all economic activity in the country.
Does that frighten anyone else?
There is one industry where fads in nationalizing industries come and go with surprising speed. Homeowners and auto insurance rates are directly regulated by state Departments of Insurance (DoIs) in many places, theoretically to ensure that insurers are not abusing their constituents either by charging unreasonably high premiums or by unfairly denying insurance coverage to certain segments of the population. The powers of oversight given to many DoIs give them the power to not just dictate what rates are and are not acceptable, but in some cases to fix rates directly, and in other cases to drive companies out of the market entirely if they so choose.
Florida is a very interesting case study. After the category five hurricane Andrew hit the Miami area in 1992, many insurers were either driven to the brink of bankruptcy or voluntarily chose to no longer sell insurance in the state, because they did not have the capacity to pay claims when a large fraction of their insured homes were destroyed all at once. This was the first really major catastrophic event to hit a heavily populated area since construction along the coasts boomed. No one really had a good grasp of what the impacts of a major hurricane would be.
Later in the 1990s and early 2000s, insurers began to trickle back into the Florida market, hoping to make some money while the hurricane trend seemed to be down. Then came the hurricanes of 2004. Four hurricanes hit Florida in rapid succession, including two hitting in virtually the same place within three weeks of one another. Large insurers were better equipped to handle the load this time, but small insurers again took a significant hit to their stability.
The massive destruction caused by the 2004 hurricanes, and the resulting billions of dollars paid to insureds, resulted in very significant rate hikes to Florida customers over the next few years. This was looked at by many in the state as adding insult to injury, given that many people were still in the process of rebuilding their lives after the damage caused by the hurricanes.
In reality, the hurricane models that insurers use to gauge the hurricane risk load were proven to be very very wrong by the 2004 hurricanes. These models consistently underestimated the damage these hurricanes would cause, resulting in rates that were very low in relation to the actual amount of hurricane risk borne by the residents of the state and by the companies that insured their property. The companies reacted to this new information by trying to adjust their rates to reflect the newly apparent risk load.
As you might expect, rapidly rising insurance costs became a hot button political issue. At first, the DoI accepted that insurers needed more premium to cover the losses from the next round of hurricanes. The governor and the DoI both publicly talked tough about protecting their citizens from the depredations of the evil insurance companies, but quietly cut backroom deals to allow insurers to hike their rates substantially. They were aware that they needed private insurers in their state.
Then came an election, and the typical competition to see who could do a better job of grandstanding. Republican Charlie Crist, “The People’s Governor”, won. If this is what passes for Republicans these days, we’re in trouble. He’s in the running to be McCain’s VP, by the way.
He decided to continue the efforts started by the previous governor to provide a public alternative to private insurance companies. The state itself started a semi-private insurance company, appropriately called “Citizens”, that “competed” in the market just like private companies. However, there are several vital differences between this company and private companies. One, Citizens’ rates are open to political manipulation. Two, if Citizens is undercharging, the state can use tax dollars to make up the shortfall, so competition doesn’t work the same as it would in a free market. Three, they will insure any one and any thing, in contrast to private companies that will only insure homes that meet minimum standards.
Governor Crist with his populist rhetoric and policies changed the way the DoI and the private insurance companies related to one another. Before, after the grandstanding for the cameras, the DoI recognized that private insurers needed to charge an adequate rate, even one that included a *gasp* profit! *gasp* if they were to stay in the state. Now, with a public insurance “company” in his back pocket, Crist could smack the private companies around at will. He decided he didn’t need them anymore.
As a result, the DoI started taking a hard line with insurance companies, refusing to grant the rate increases they needed to cover their expected losses. Can you guess what happened next?
The state’s largest homeowners insurer is pulling out of the state. Virtually every other major insurer has declared that they will no longer be selling new policies, and they are dumping existing policies at a rapid clip. Who’s going to take up the slack? Give yourself ten points if you guessed Citizens.
Crist has de facto nationalized the homeowners insurance industry in his state.
Two things about all of this fascinate me.
First, the people in the state don’t seem to understand that they have made their situation worse. The reason you pay money to insure something, other than the trivial reason that your mortgage company may require it, is that you wish to transfer the risk involved in owning that property to someone else. You are willing to pay them a fee, the profit built into your rate, for them to assume that risk. If your house is not destroyed in a given year, they make a good bit of money off of you. If your house is destroyed, they will likely pay out more than you have ever put in or could ever have saved. That insulation from risk has value to it. Insurance companies have a surplus, effectively money accumulated in the bank, to pay out when a catastrophe strikes. Companies mostly expect states to pay their own way, that is to pay premiums that correspond directly to their expected losses, but it doesn’t always work out that way. The 2004 hurricane season, for example, caused losses that resulted in every insurance company digging deep into their own pockets, well beyond what Florida residents had paid in.
What the people of Florida don’t seem to recognize is that now, those deep pockets that will be dug into when the next catastrophe strikes are their own. How this could be considered “better” in any objective sense completely baffles me. Any savings in their homeowners insurance bills are necessarily compensated by higher taxes.
Second, and I’m sure this will be a shocker - this has been tried before. Not always in identical circumstances or by identical means, but it’s been done. One example that immediately comes to mind is the New Jersey auto insurance market. Rather than setting up a private insurer, the state decided to regulate private insurers so heavily that they had little freedom to charge rates they considered appropriate. It wasn’t literal nationalization of the industry, but regulation so heavy that uniformity is required is effectively the same thing. The result? Few insurance options, high rates, and poor coverage. After about fifteen years of this, the state tried an experiment with deregulation. Real deregulation, not the typical half-way deregulation that never works and then is held up as evidence that deregulation doesn’t work. The result? Lower rates, better coverage, and insurers streaming back to the state in droves to compete for customers. This is happening right now, but the Florida government, in an attempt to pander to it’s citizens, can’t be expected to pay attention to such things.
What’s the definition of insanity? Doing the same thing over and over again and expecting different results.
I’m not sure that’s exactly what’s happening here, because I’m not sure that the Florida government cares what the results are. They seem to care for nothing beyond short-term popularity.
Under normal circumstances, I wouldn’t care what the people in the great state of Florida do to themselves. However, if Crist gets chosen to be McCain’s running mate, I will have no choice but to be concerned. Democrats are the ones that are supposed to use nationalizing industries as a tool for political gain, not Republicans.
Comments
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It seems that more and more Republicans have decided to follow the “If you can’t beat’em, join’em” idea.
It is near impossible for the R’s to lose conservative votes, due to the D’s being so far left. If the R’s want more votes, where do they get them? By competeing in the bread and circuses contest with the D’s of course.
It is a shame that there is not a Conservative Party. Or if there is, one that is viable.
Cobar | 3/9/2008 01:41 PM CDT -
The same manipulation (and way more) in the health insurance field is a very large part of the reason we’ve got a healthcare crisis in this country.
Matt | 3/11/2008 01:06 AM CDT -
Government screwing around with insurance REALLY riles me. Especially living here in Michigan.
Having come from a conservative province where insurance companies wqere allowed to compete, my driving record made a difference. Because I was a good driver and had zero claims in my history, I had good rates. Which didn’t go up each year.
I (got) moved to Michigan.
Michigan is a no-fault state. Because that shields crappy drivers from not being able to afford insurance. AND we have a huge theft problem in the state, mainly in the 3 worst cities in this part of the country (and all 3 near the top of the worse 10 US list) - Detroit, Flint and Saginaw.
So, to balance out the high rates caused by punishing good drivers to keep bad drivers voting Democrat, they make a bad situation even worse. Much of our vaunted “excellent” hospitals have fantastic equipment because of a little game played to “protect” insurance companies from high injury claims. We get to pay a Michigan Catastrophic Claims premium on EVERY doggone vehicle we insure. Currently, based on my 4 motorcycles and 3 vehicles, I am paying over $1000 a year just for that silly premium, and also forced to pay an additional premium for mandatory medical coverage. ???Hey, I can understand some forms of government run businesses. I worked for the Cnadian equivalent in my youth - they’re called Crown Corporations, and they mostly exist where private industry cannot afford to exist. I worked for the Northern Canada Power Commission for 3 years, in the arctic. They provided power to most of the small communities in the high arctic ... since no sane company would try to make a profit there. I can live with that ... but NOT direct competition with comanies they force to pay taxes to be in business!
Shades of Hugo Chavez!pete in Midland | 3/11/2008 08:56 AM CDT -
The “crown corporation” idea makes some sense, in some cases. The trouble is that it’s hard to define the line between the cases where it makes sense and the cases where it doesn’t.
pete says that “no sane company would try to make a profit” selling power in Northern Canada. This may or may not be true in an undistorted market, and if it is, then the NCPC is doing a job that is undoubtedly necessary and will be done by no one else. But it’s _certainly_ true in a market where NCPC does already exist, and because of state backing can afford to set the market price at an unprofitable level.
I’m not familiar enough with the electric market there to bet one way or another on whether it really could be profitable for private industry in the area, although the sparsity of population and high cost of distribution infrastructure actually incline me to give his view the benefit of the doubt.
But in the absence of free competition, we can never know for sure, and the edge cases are a lot more common than the probably-obvious ones like NCPC.
And of course the insurance market isn’t even an edge case. We know for a FACT that private enterprise is willing to sell insurance against just about anything when government doesn’t chase them out of the market by unfair competition or insane overregulation, because the free market for private insurance did already exist before the government stepped in and killed it.
Matt | 3/11/2008 12:57 PM CDT
