Friday, October 3, 2014

Why doesn't insurance cover floods, earthquakes or bed bugs?

Planet Money has another episode that is making me rethink my opposition to government subsidies for public broadcasting.  In The Fine Print, a reporter reads his homeowner's insurance policy.  In it, he discovers that the policy does not pay for:

  • Floods: because floods hit all the homeowners in an area at the same time, so insurers cannot spread the risk around (called "correlated risk");
  • Earthquakes:  due to adverse selection (only the homeowner knows if she built on an active fault); and 
  • Bedbugs:  due to moral hazard (if you knew you were covered for bedbugs, you could pick up furniture off the street without any worry).  

20 comments:

  1. So I understand that they cannot correlate the risk with flooding and flood insurance has been left with a Federal program instead. The unsaid challenge is that they haven’t figured out how to price a potential flood insurance rider against the actuarial risk or the premiums would be so absurd that no one would pay them.

    According to the FloodSmart.gov website, people who live in moderate-to-low risk areas pay premiums as low as $129 ($643 for a commercial building and its contents). That $129 premium currently covers $20,000 in building and $8,000 contents coverage. Most of the claims for the entire program come from two states: Mississippi and Louisiana. Even after reforms to the current program through 2004, the federal program is in debt by $24 billion.

    So the Federal government has not been able to provide any level of policy premium reconciliation that would reduce the amount of money the taxpayers will have to pay in the context of the debt being $24 billion.

    Why not allow insurance companies to develop and manage a risk pool of available flood insurance coverage for homeowners who have low to moderate flood risk? Perhaps the market would be a better arbiter of what the premiums for low-to-moderate risk should be or at least reduce the amount of red ink currently generated by the federal flood insurance program.

    Reference:

    Homeowner. (2014). Retrieved from https://www.floodsmart.gov/floodsmart/pages/residential_coverage/homeowner.jsp



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  2. Signaling is done it many facets of life. Insurance companies are a good example. If a consumer feels confident that their driving is exemplary they can sign up for a program such as SnapShot from Progressive insurance that tracks your driving habits through a devise plugged into the dash. They say they are only tracking how much you drive and how often you hit the brakes and how hard.

    But I believe this is extracting information under false pretenses and it gives the insurance company the ability to charge you more money, not less. Yes, they give you a discount to sign up, but there is not real evidence that individuals have saved money over time. How do they know why you slammed your brakes? Maybe a deer jumped in front of your car, someone steered into your lane, or maybe a child ran into the street to retrieve a ball. But you slammed on your brakes; bad driver.

    Consumers should be careful about the kind of information they give to people when they are trying to purchase products and services. When purchasing a new home, your agent will ask you questions. When you find a home, they will want to know how much you would be willing to pay in the negotiation. While the buyer’s agent is there to assist the buyer and be their representative, the more money the house sells for, the more commission they make.

    It has been my advice to my friends, family and myself, not to divulge how much I am willing to pay. To make the offer, hear the counter offer, and determine if I want to go forward. If the buyer’s agent already knows what my bottom line is, they may not work that hard to get me a better price.


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  3. The same reason some life insurance policies don’t cover someone dying of natural causes versus accidental death another one of those things “in the fine print”!
    Regardless, decision making is a process. Before I retired from the military I had to do a lot of decision making under uncertainty. The golden rule is “The correctness of decision made under uncertainty is uncertain". The first step is: Don’t get emotional, dogmatic of the decision made under uncertainty. It could be wrong. Second: keep an open mind, listen to critics and other views because they might be right and be prepared to modify and even make a complete U turn or abandon a decision as more facts are available and uncertainty is reduced.
    Third-keep enough reserves that if required modifying or altering the decision there are enough resources to work. Fourth commandment- hedge or take insurance on such that if the decision turns out to be a complete failure, you could start again. Fifth: execute the decision with a political will and with confidence that the correct decision has been made. The decision could be correct but it will fail because of lack of confidence.

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  4. Let’s face it the insurance companies are in the business to make money, so no the odds are you will never get all the money you will pay into it in the first place. As stated in the text, “Risk can be quantified, estimated, and hedged. Uncertainty cannot. Don’t mistake the risk for uncertainty, and try to design institutions flexible enough to deal with unforeseen contingences.”(Luke, McCann, Shor, & Ward; 2014) So, the insurance companies are not willing to put itself in a position to lose money. Think about automotive insurance, the policy is normally most expensive when you first get your license, because statistics show that the probabilities of individuals of getting into an accident age are higher when at a younger age. Then if you get into an accident your rates increase and if additional incidents occur after that, then you are at risk of having your policy dropped and may not be able to get a policy anywhere else. The insurance companies are taking calculated risk to make money, they are not in the business to supply us money. Remember Insurance is more of a just in case, or worst case scenario, and the more the likely hood it will happen the more expensive it will cost you. For the companies it a calculated risk not an uncertainty or certainty that it will happen.

    Luke, F., McCann, B, Shor, M., & Ward, M. (2014). Managerial Economics; A Problem Solving Approach (3rd ed.). Mason: South-Western Cengage Learning

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  5. I didn’t know that you could not get insurance for bed bugs – it’s a good thing I don’t need it. As we know, we can’t asses the risk of acquiring bed bugs. My wife’s interpretation of roughing it in the Adirondacks is: having to put ice in her Saratoga Water because the cooler at the Sagamore went down. If the insurance company thinks there is less of a chance to attract the little critters from the Sagamore than there is form any number of the roadside motels between the village and the resort, perhaps our bed bug premiums would be lower than that of a person who frequents one of the motels. Of course there is it discrimination issue, which is the insurance company would have to ask what types of accommodations you frequent. This type of screening process if not allowed.

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    1. It’s interesting the exclusions of coverage found in insurance policies. Insurance companies spend a lot of time determining and accessing risk. If I were to guess, insurance companies are probably up there with the government regarding stats. If you lose a limb and it “happens” to be covered, they have already determined the limbs financial value. It seems dissociative of the human experience. We are at times offered coverages which make the policy seem valuable on paper but in actuality hold little value as the probability of the need for the coverage is virtually non-existent. But profit on these type of coverages allow coverage for more likely losses. However, insurance companies are in business for profitability. If there is no profitability or if marginal cost exceed marginal revenue insurance companies would dry up leaving many to many would suffer insurmountable losses. Insurance companies are also in the business of covering themselves against added exposure due to moral hazard. I had not thought of this before, but moral hazard does happen, perhaps more often than we think. For example, as I consider my own cell phone care, I am not as careful as I should be at times since my phone is insured. I don’t mean to intentionally be neglect of my cell phone but caring for my cell phone is not predominate in my mind since I am insured. On the other hand, that’s why I pay for the insurance.

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  6. The first important lesson in this chapter was: “Anticipate adverse selection and protect yourself against it.” (Froeb, 225) That being said, that is exactly what insurance companies do, and quite well I might add. While we may be paying them in anticipation of possible future downfalls, they are assessing which ones they can make money on and which ones they will lose money on. And they are much better at it than most of us because they are better informed than most of us on these things. So we, being less informed, and sometimes forced due to bank loans with stipulations for insurance, have no choice but to insure ourselves for the “maybe’s” that we could encounter down the road. And of course we are hoping all the while that we will never have to actually use the insurance, which is exactly what they are hoping, and counting on, too!

    Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial economics: A problem solving approach (3rd ed.). Australia: South-Western Cengage Learning.

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  7. The uncertainty of costs related to the pursuit of moving a lower asset to a higher asset outcome can dramatically affect how a decision is calculated. Insurance companies rely on historical information and analytics to improve revenue outcomes against the costs that arise from insurance and/or reinsuring risk pools. Natural disasters as well as acts of war or social disobedience that destroy property and lives can disrupt and destroy both the insurance firm’s existing assets and additionally disrupt the capacity of an overall insurance industry to support other lines of insurance pools in other demographic areas. Reserves and pricing plays a critical role in the decision making process of whether an insurer or reinsurer will risk its current and future assets. If insurance “A” offered flood insurance in coastal areas, the risk assumed can reach billions of dollars that may not be covered by reserves or reserve standards since the cost of a disaster would be very high due size of private properties within the coastal areas(e.g Hurricane Katrina and Sandy). This reserve affect prompts the need for private reinsurance but in the case of such a high cost private reinsurers may not have the reserves to reinsure the insurance companies because of the total sum cost of the risk in such a pool. Assets are not endless for any firm regardless of size nor could spreading the risk support the level of possible loss in such disasters.

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  9. Luke, the maxim that “the one certainty in life is uncertainty” is the insurance industry’s unsolvable puzzle. We have learned that risk “can be quantified, priced and traded”( Froeb, L., McCann, B., Shor, M., & Ward, M., 2014). Contracts written for homeowners in Florida used to be inclusive of many acts of God. After Hurricane Andrew ripped through Miami in 1992, many insurers who had enjoyed 40 years of stable profits now faced staggering losses. Over the next 15 years hurricane activity increased and insurers, in a bid to limit future losses, had broken up policies into subcategories for the homeowner. For insurers, they have adapted to limit their risk. They knew with certainty they would incur loss and now better analyzed how the hurricanes would cause them going forward and have raised rates as a result.
    Insurance companies had rewritten their contracts and homeowners had not always realised these changes. For example, hurricanes can cause damage through wind blowing water into a house, blowing a roof off the house, or blowing debris into the path of the house. The policy may specifically include or exclude this from the policy. The delima for the homeowner may come after the hurricane that all the water damage came from wind tearing part of the roof off, which the homeowner was not covered for, and a flood insurer may deny coverage stating the inital is a result of the wind. This “blame the other guy” tactic is now being experienced by homeowners when making property claims.
    What homeowners in Florida have found out is that despite one hurricane doing the damage, each insurer has been able to limit their risk. For the homeowner who has limited resources and has to choose which policies to purchase, he/she has now bear the uncertainty of which policy is best for their circumstance. With changes in the law recently, homeowners in Broward and Palm Beach county can make choices what insurance to carry (Hurtibise,R., 2014.) Homeowners bear the double dilema of being uncertain where future damage will happen and underestimating risk to the property and its contents.

    Hurtibise,R., Sun Sentinel, 2014. Refer to (http://www.sun-sentinel.com/fl-flood-insurance-keep-or-ditch-20140920-story.html#page=1) Accessed on 5-01-2015.
    Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial economics: A problem solving approach (3rd ed.). Australia: South-Western Cengage Learning.

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    1. I should also not that insurers minimize their exposure to a world of uncertainty by quantifying their known risks based upon previous actions of the insured, current trends, census data, etc.,
      ; minimizing risk should ideally minimize the uncertainty of a future events causing losses greater than the insurance company can absorb.

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  10. I’d like to point out that advserse selection worked in the favor of homeowners for decades in South Florida. Historically there have been weather patterns that, stated below, insurance companies either neglected to fully recognize or miscalculated for reemerging in the late 1990’s and early 2000’s.
    “The number and strength of Atlantic hurricanes may undergo a 50–70 year cycle, also known as the Atlantic Multidecadal Oscillation. Nyberg et al. reconstructed Atlantic major hurricane activity back to the early eighteenth century and found five periods averaging 3–5 major hurricanes per year and lasting 40–60 years, and six other averaging 1.5–2.5 major hurricanes per year and lasting 10–20 years. These periods are associated with the Atlantic multidecadal oscillation. Throughout, a decadal oscillation related to solar irradiance was responsible for enhancing/dampening the number of major hurricanes by 1–2 per year.” (Chylek, Petr; Lesins, Glen. 2008. "Multidecadal variability of Atlantic hurricane activity: 1851–2007).
    It would be conjecture to say what insurers reasoning was during this time in the late 20th century, but they did write policies not accounting for the increased activity and the need to write policies accordingly. They suffered the trifecta of problems from risk of loss, the uncertainty of the cycle coming around and hitting Florida dead on, and homeowners accepting comprhensive policies at lower prices. The homeowners felt they were covered in a comprehensive manner and were charged a fair and reasonable price for years and were not prepared for what came next.
    It was only after the 2005 season the insurance industry in Florida mounted large losses and had to respond by aggressively raising rates (Anderson, Z., 2013). What has transpired since then has turned the tables back in their favor. As the activity has subsided Floridian homeowners filed claims in 2012 at the astoundingly low rate of 1 claim to 1000 policies. With less hurricane activity being the trend for the moment, will insurers change their tolerence for risk again and price policies lower or are the good days for homeowners gone for forever?

    Chylek, Petr; Lesins, Glen (2008). "Multidecadal variability of Atlantic hurricane activity: 1851–2007". Journal of Geophysical Research: Atmospheres 113: D22106.
    Anderson, Z., 2013. “Florida most expensive in nation for home insurance”. (http://www.heraldtribune.com/article/20131217/ARTICLE/131219638) Accessed 5-01-15.

    Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial economics: A problem solving approach (3rd ed.). Australia: South-Western Cengage Learning.

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  11. This is definitely a good case of screening on part of the insurance companies, who are looking for adverse selection. As stated, floods typically wipe out large areas at the same time. While there probably is a financial model that works for insurance companies to insure against floods, the pricing of premiums would be higher than people who live in non-flood zones would be willing to pay. The national flood insurance program is less like private insurance because the government doesn’t use risk to price premiums. It is very much like how the federal government doesn’t use credit checks as a requirement for student loans. While a bank would use screening for creditworthiness, the government takes a higher, across-the-board risk. When it fails, the taxpayer pays. In a way, this may be a form of moral hazard for the government, since it really doesn’t have to pay (the taxpayers will) when it makes decisions about flood insurance and other government products that are designed to look like normal private-market financial products.

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  12. I live on a lake and my home owners insurance does not cover floods because of the fact that there is a great chance that it could happen at some point. I was 21 years old when I bought the house and could not believe that flooding was not covered in the policy. Now that I am a bit older and understand more about the reasoning behind these types of decisions, I can completely understand why there is no coverage for this. For what we pay for home owners insurance, why do they want to take a chance that our house will flood and they will have to pay out a large sum (possibly more than we have even paid them), especially if our area would be considered a potential flood zone. I can understand why this would be the same case for not providing earth quake insurance for many of the geographically areas that commonly experience these sort of things. However, the bedbugs is throwing me for a loop because I do not think that having this coverage would make me more apt to go out and grab a sofa and chair off of the side of the road if I thought for one minute that there was a possibility of bugs in it. Floods and earth quakes are not something a person can naturally avoid on their own, but bedbugs is greatly more avoidable, therefore, I do not know if it is necessary to include this in the policy as not covered.

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  13. If the insurance industry was a non-profit - then maybe I could understand them not covering for floods. However, they are a profit making business. Are they covering you for the house or not? Just answer the question. The answer should be yes. Not yet, but......

    Like a business they are taking a risk. So, if a flood happens and they lose. They lose. A business write off - no less. Just like any loss in a business - maybe a bad economy, etc.

    However, I do not like insurance companies because like it was stated before they are not doing charity work. That is a thought - maybe the government should take over the insurance making industry.

    Because I think the insurance industry is too profitable - if anything. They are not starving.

    For instance, car insurance - I pay about 60 a month for my car. In NYC, I paid about $300 a month for my car. I have never been in accident in over $30 years.

    However that is not the point.

    Here is the point - I pay $60 a month now. About $2 a day. Every driver in America - guessing is around 100,000,000. Take $2 a day times $100,000,000. Equals $200,000,000 A DAY...

    Do you think they make payouts of anywhere near $200,000,000 a day? A DAY? Let us not even go by the week or by the month or by the year.

    What are their costs and expenses besides the payouts and the advertising?

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  14. Another good one! I live on Long Island and I am all too familiar with what insurance will or will not cover; the rules have changed since Irene and Sandy. The insurance companies use these storms as their basis to deny coverage, citing all kinds of stats about the associated risk. Fortunately my house was not damaged during either storm, but we had to deal with my mother in law’s home which was crushed during both storms. She lives on the water, so I do understand the risk of another storm throwing her house into the bay. Of course another storm hitting Long Island is not guaranteed, but as we know from our readings (Freob ET all, 2014), uncertainty cannot be eliminated. Again my home was not damaged in either storm and according to FEMA’s new flood zone map I am not even in a flood zone, yet I am impacted by insurance rules. I recently signed on to have solar panels placed on my home, it was a great deal. During the negotiations I asked the salesman if the panels would be covered under my home owners insurance. He explained that there was no need to even tell the insurance company that I had panels installed. He further explained that since the panels were leased the solar company would replace damaged panels, unless of course it was deemed that I was damaging them myself. So I took it a step further and asked “what if another storm hits”? He replied that I was not in flood zone and my area was not hit too hard. He added that there was limited risk and that I shouldn’t worry about something that may never happen again. It kind of made sense so I went with the deal, contingent on speaking to my insurance company.
    Fast forward to the next day and my insurance guy completely debunked the salesman’s pitch. He said that solar panels are not really cost effective, at least yet, because the insurance companies are not sure how to deal with them. Although a storm may never happen again, we still have to consider the potential; especially on Long Island. We know that roofs flew off homes during the last two storms, so there is a risk that the panel will go with roof. He explained that they have to be added to the policy with an increase rate, which would eliminate the financial benefit to me getting them installed. I called the salesman for clarification and actually received an honest answer. He told me that he has panels on his house, adding that he never actually told his insurance company about the panels. He is purposely not telling them because he is not worried about a storm hitting his house and is enjoying the cost savings that they offer. To me this is too much of a risk. I couldn’t go through with the deal, if there was potential for my uninsured panels to fly off the roof and land in my neighbor’s bed room. The risk outweighs the advantage for me, so my decision was cancel the order. For my salesman the benefits of a guaranteed cost saving outweighs the potential of having his neighbor wake up with a panel in his bed, so he decided to go with the panels. Anyway that’s my story about risk, uncertainty and decision making.
    JG
    Froeb, L.M., McCann, B.T., Ward, M.R. & Shor, M. (2014). Managerial Economics: A Problem Solving Approach. Mason, Ohio: Southwestern Cengage Learning.

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  15. This caught my eye, to be honest mainly because of the bed bugs. This is a fear that comes along with life on the road and being in hotels all the time. However with moral hazard taken into account, if it was covered, people would probably stay at less expensive establishments because there would be less fear associated with acquiring some new friends. I am sure companies such as mine would be less concerned of it as a whole and possibly even require that we hold insurance to protect against it(if it existed) which in turn would mean they would take more risk with hotel selection. Insurance companies are in this case and other anticipating moral hazard and doing what they can to protect themselves against it.

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  16. The article mentions three problems with issue. The mainly bed bugs issue points to moral hazard. Although there may be some truth with moral hazard issue, I disagree with the blanketing that consumers become less risk averse if they are aware of safety nets. I find this bizzare to generalize as it is somewhat comparing apples to oranges. I totally agree that in most cases, someone one would not jump out of an airplane without a parachute, but on 911, people were reportedly jumping out of windows without parachutes. It indicates that if one has good health insurance coverage and one wouldn’t care as much about getting sick. If that was the case, why dentist have to keep begging patients to visit? And why do patients with good medical coverage refuse to visit the dentist when they should?

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  17. Whilst our parking project hopes to tease out the locations of the many bike racks scattered around Cardiff, what is a bit harder to quantify is how safe your bike will be if it is locked there for any length of time.See more http://ethanproperty.com.au/regions/joondalup/

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  18. This article has to deal with adverse selection and moral hazard. Although many homeowners pay a ton of money for insurance, there are some things that insurance won’t cover such as floods, earthquakes, and bedbugs. I think that it makes sense that insurance won’t cover these. It isn’t up to the insurance companies to pay when a flood or an earthquake hits. When someone is buying a house, it’s up to them to know if they are building or buying a house in an area where floods or earthquakes happen frequently or are known to happen. Adverse selection is when information is not so transparent. Usually one party has more information than the other. This could happen when someone is buying a home. Some people could claim that they didn’t know earthquakes could happen where they bought a home. I think in this day and age information is more transparent especially with the internet. It’s easier for anyone to be able to discover information. Many people when selling a home to another party will signal if there is something to know. Signaling allows information to flow from the informed to the uninformed party. Insurance doesn’t cover bed bugs because of moral hazard. If someone could buy insurance against bed bugs, people would hide their actions to the insurance company and purposely buy mattresses with bed bugs just so they could get the insurance money. Bed bugs arise from people’s actions and I don’t think they should be covered by insurance. Insurance companies get scammed too much so they have to put further screening processes in place to protect themselves from losing money.

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