People view insurance as an investment rather than as a protective activity. That is one of the basic misunderstandings. As a result, if they haven’t collected on their policy, they will cancel it because they feel that, in some sense, it was not a good deal — rather than [acknowledging] that the best return on a policy is no return at all. On the very low-probability of events, which is where insurance is most valuable, people say [a low probability event] is not going to happen to me. I don’t have to worry about it. I won’t protect myself.
When I go out and buy a clothes dryer, I put down my money. In a few days, the clothes dryer shows up at my house, and it is what I ordered. That’s that. But with insurance, you put up your money in the first instance, and if you are lucky, you get a cheesy piece of plastic that indicates you have insurance coverage. But what you are going to get is determined later by whatever happens. Once a bad event occurs, it is easy for people to forget the details of what they agreed to when they put down their money, and to think that they should be entitled to things that may not have been covered in the contract.
That’s not the only example where people sign long-term contracts. But it is a good example, and it is actually worse than most long-term contracts, because the whole intrinsic idea is that uncertainty and unpredictability will intervene, which makes it easy for people to be confused about whether they made a smart decision in the first instance.
The nature of insurance, of course, is that in a sense, everybody who buys insurance makes a dumb decision. Either you paid your premium, and then you didn’t suffer a loss — we claim that the best return from insurance is no return at all — or you did pay your insurance and you suffered a loss, and you wish that you hadn’t, because [the insurance] didn’t cover everything. Either way, people tend to be dissatisfied.
Insurers also sometimes misunderstand their business, particularly when dealing with catastrophic events. Regulators of insurers often misunderstand insurance as well because, like the rest of us, they want it to do everything good in the world. But sometimes, that’s not always possible.
A lot of people do not purchase certain types of insurance, including, flood, fire, hurricane, etc., because they say, “It is not going to happen to me.” And they really don’t think about this low probability event. So from that vantage point, I think you have a major problem with respect to how that insurance has to be packaged.
There are two things I think that are normally done to deal with that. One is that insurance is required as a condition for a mortgage. In the case of flood insurance, that actually happened after [the National Flood Insurance Act], which was passed in 1968, revealed that so few people actually purchased it. They changed it in 1972 to require that any person who was living in a flood-prone area where flood insurance was available — and who [also] had a federally insured mortgage — had to buy [flood insurance]. So the requirements are a very important part of this. The other part that really makes this very challenging is the issue of affordability. It becomes extremely hard for people to somehow say, “I really have to have this insurance” when it is so expensive. In addition, the law requiring flood insurance was never very well enforced and has not been well enforced today.
So there are an awful lot of people who still don’t have flood insurance even if they are required to have it. And many people who were required to get it after a disaster – to get some type of disaster relief — canceled their policy a few years later even though they were required to have it. So we have a real challenge here in terms of how to deal with this.
I have been have been paying a great deal of attention to the Flood Insurance Reform Act of 2012. I can see a big concern on the part of people – of Congressional legislators – wanting to change that. What I’d like is for someone to try to bring forth two principles – risk-based premiums and means-tested vouchers – into confluence so that we could not only save the government money, but also make the homeowners and people who are living in these areas feel that they can afford these premiums.
The idea is simple. If it turns out a person is going to get a voucher because his or her premiums are extraordinarily high – either because new maps have been drawn or simply because the subsidized rates are taken away from them – we would say that you can have [that] voucher. We’ll also give you a loan to help you make your house safer – to elevate your home – but that, as a condition of the voucher, you have to mitigate. You have to elevate [your property]. It is a carrot and stick approach that we are pushing forward…. Our feeling basically is that the government will actually be paying much lower vouchers because their insurance premiums would go way down. Homeowners would also find that they are better off because they are in a position where they have a much safer house.
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