Monday, January 28, 2013

Would You Rather...
The Florida Chamber of Commerce has been playing a Would You Rather game with the Florida Senate and public.  The Chamber reports that
73% of Citizen policy holders would be willing to pay 3% more for their Citizens Insurance policy in order to reduce their maximum assessment to 15% in the case of a major catastrophe.
So what does this mean for policy makers?  Well, for (presumably) knowledgable decision makers, it shouldn't mean much because the wording of the poll most likely had a great deal to do with its outcome.  Implicit within the phrasing is a Would You Rather game. Roughly speaking, in any given year Florida runs about a 1% chance of a Citizens PIC deficit.  So the game goes like this:

a)100% chance of a 3% increase in the price of windstorm insurance and a 1% chance of a future increase not to exceed 15% 
b)100% certainty of no increase today and a 1% chance of an unknown increase that may exceed 15% in the future?

Predictably, the majority of those polled chose the former option, a 3% increase.  I say predictably because humans are generally risk averse.  We generally prefer the certainty of a known cost to the probability of an unknown and potentially high cost.  This natural behavior is one of the main reasons we are so willing to buy insurance in the first place. 

Policy makers should be hesitant to react to the findings of this poll and its suggested policy for at least three reasons.  

1.  The expected costs of the Chamber's policy is greater than the status quo.  
Consider a hypothetical windstorm insurance policy is $100.  

The first option results in a total expected premium cost of $103.15 because 0.03 * $100 = $3 and [0.01 * (0.15 * $103)] ~ $0.15.
Let's say the hypothetical increase in the second option is an absurd 100%.  The total expected cost of the second option is still less at $101.00 because [0.01* (1 * 100)] = $1.00.

Even still, the upfront cost of option A may be worthwhile if future risk is curtailed.  This brings us to the second reason that policy makers should not take this poll too seriously.

2.  An increase of 3% will not significantly decrease the likelihood of a Citizens' insolvency or need for assessment.  
Citizens is, by many actuaries' expert opinion, woefully undercapitalized.  The worse case scenario for Florida, a hurricane season causing a couple to several hundreds of billions in insured loss, could result in major destabilization of the state's insurance market, assessments, and political upset.  A 3% increase will not raise the many billions of dollars needed but only about $85 million, bringing annual premiums from about $2.8 B to $2.9B.

3.  The Chamber's policy is only a further politicization of the hurricane risk.  
Consider that decisions about future assessment rates will ultimately be made by an evaluation of how much the public can bear at that time (and who in the public can bear it).  Thus, the Chamber has suggested that uncertainty surrounds future decision making which could cause individuals an annual loss of more than 15% of premiums.  For a price of 3% of premiums, that decision making uncertainty will be controlled.  In effect this is a separate risk being insured against through the use of a Citizens policy.

Perhaps, then, the most that can be extracted from this poll is some indication that the public is willing to pay a small upfront cost to diminish future catastrophe and sudden increases in cost.  It is the burden of decision makers and experts to use such resources to develop a cost effective means of improving the affordability of the hurricane risk for the Florida public.  With the public willingness to contribute $85 million a year, such an endeavor seems plausible.  

Further politicization of the hurricane risk by incorporating uncertainty about decision making outcomes within the cost of insurance will not adress Florida's needs.  Instead, it is only likely to increase perceptions of Florida's government as a risk itself.

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