. It would obviously be disgusting for the government to renege on its promises now. That is: the government must pay up on its existing insurance policies. However, I do think that insurance should be phased out.

I sort of agree but what I’m getting at is that you may not be aware that people live in these areas that are currently uninsured anyway. They own their homes outright because their granddad worked until the day he died to put down the last dime on the $10,000 mortgage. The remaining generations just continue to live in the same house and pay land tax. Some may not even be aware that they need insurance. So they simply go uncovered. Then you have people who might have some form of insurance who are on the edge. If you make their insurance go up, they may simply not bother having it anymore. The choice for some people isn’t between paying more insurance and moving someplace cheaper, there’s the third choice of doing without and hoping nothing bad happens. So if you bump up insurance rates, instead of having private firms defraying some of the cost, you’re shrinking that and putting more weight on the governemnt.

I suppose the question is: is the cost you lost to people doing without offset by the people who do leave? Also, if people leave, does that make demand go down, which makes houses cheaper, which lowers insurance rates, which makes people think about chancing it and buying a house in such locations? Etc. Etc.

Stupid feedback loops ruin everything! :)

Second, as for people not being rational actors: I think you’ll find that if their premiums go up to reflect the actual risk of a flood, they will move away. That makes them rational actors.

I can’t think of any good argument for supporting people’s continuing to live in a place where there’s a substantial risk of their being wiped out, and subsidizing that with insurance policies that don’t properly reflect that risk.

Now, let it be noted at the outset that I don’t know a thing about flood insurance, insurance for homes on the Gulf Coast, etc. I could be totally wrong about it. I fully accept the possibility that someone who knows what he’s talking about could make me look like the fool that I am. But in principle, I don’t see why the government owes people anything just because their ancestors lived there. If it’s so important for these folks to live where their ancestors lived, why shouldn’t they pay a cost that reflects that importance? “Because they’re poor and can’t afford it” isn’t really an answer, because again: I don’t see why there’s any societal interest in keeping people — poor, rich, or otherwise — where their ancestors lived. (Note that there may well be a societal interest in putting poor kids in wealthy towns, if doing so gives the kids access to better schooling. I can see other arguments along those lines. But none of them applies here.)

People are forced to leave places all the time because it’s too expensive there. (Think “gentrification.”) Does society have an interest in letting the poor people who used to live in JP continue to live there?

On your last post, about hurricane insurance: it may well be the case that we shouldn’t be subsidizing people’s habit of locating in dangerous places. There’s a powerful argument in that direction, obviously: if you can’t bear the risks of living in a given place, then why should society be picking up the tab?

Because they are poor and live there already? Also, people are not rational actors and live somewhere because that’s where their family lived since forever. This means people will live stupid places and if enough people do it, what are you going to do? Just say “Oh well, we told you so. Sorry you’re drowning right now.”? I mean, I guess we basically did that already with Katrina to some degree. It didn’t turn out too well then, either.

Basically, if you’re going to be descent you have to deal with both the guy who’s capable enough to insure himself and help out the guy too poor to insure himself but who has to live where he is anyway because you’re a decent human. The question is, how do you explain that to the guy who is capable enough? Or, perhaps, why should you have to? Is he not a decent human too?

But this is a different topic.

In general, I have a vague story forming in my head about where risk goes. Everyone is hedging everything: insurers hedge their risks, reinsurers hedge theirs, etc., etc. The story is supposed to be that I can hedge away as much risk as I want, leaving behind a diversified portfolio with exactly the risk and return that I want. That hasn’t quite worked out as planned.

The vague story says: there’s a certain amount of risk in the market. That fundamental level of risk is not going to go away. It’s a “noise floor,” so to speak. You can push it around — hand it from insurer to reinsurer to portfolio holder to, ultimately, government, but it’ll still be there. So microeconomically — on the level of an individual actor — you may be able to get rid of it, but macroeconomically — the total level of risk in the market — you cannot. It’s simply not the case that all actors can get rid of their risk simultaneously.

I know the counterarguments to this, of course. A company like AIG is supposed to have a massive portfolio of everyone else’s risks. All those other risks are supposed to be uncorrelated. If they’re uncorrelated, then the Central Limit Theorem leaves AIG with a bundle of risk at the end of the year that it can quantify precisely. If those risks are correlated, then we have theorems for that. But again: they didn’t help. Is it just that AIG (or whoever) got the correlations wrong? Is it still possible to construct the magically riskless portfolio?

I don’t know the answer, of course, but this is the direction I want my reading to go in.

Again, the ultimate reinsurer is the government. We want this; we don’t want insurers to be able to fail. But in exchange for this protection, they need to be only ensuring things safely, need to have sufficient capital reserves, etc.

In the case of a difficult-to-ensure thing, like mortgages, I don’t know whether the appropriate answer is to forbid ultimate government reinsurance on anything unstable, like mortgages, or just to set the capital-reserve requirements as high as necessary.

Here’s where I want to dig into the numbers: if an insurance company wanted to write policies to protect against even something as terrible as the mess we’re in now, how large would the premium have to be? If you expect this to happen once every hundred years, the premium might not have to be so large: catastrophic damage once per century doesn’t turn into much per month. However, you have to be really, truly sure that it’ll only happen once per century. If your model is off, your premiums will be set wrong. And we don’t want the government insuring unknown risks.

Or maybe we do, to get back to Adam’s point. Maybe it’s good for society to insure against that kind of risk, and have the government do the insuring. But that’s a separate conversation. I think the reason we have private insurers, rather than just having the government insure everyone directly, is that private insurers can go out of business, and hence have an interest in judging risks properly. Government doesn’t have that self-preservation incentive. So there’s obviously a good argument for having private insurers.

Now, if no private insurer will pick up some risk that society thinks ought to be insured — like mortgage risk — then we ought to ask why, and we ought to ask how to structure government insurance. Maybe look at flood insurance as an example. How does that work?

I don’t know if I’m taking us off-topic. I’m trying not to, honest.