On the subject of flood insurance…
A loyal reader emails:
In the seminal Kydland and Prescott (1977) paper on time-inconsistency, they give this flood-related example:
The issues are obvious in many well-known problems of public policy. For example, suppose the socially desirable outcome is not to have houses built in a particular flood plain but, given that they are there, to take certain costly flood-control measures. If the government’s policy were not to build the dams and levees needed for flood protection and agents knew this was the case, even if houses were built there, rational agents would not live in the flood plains. But the rational agent knows that, if he and others build houses there, the government will take the necessary flood-control measures. Consequently. in the absence of a law prohibiting the construction of houses in the flood plain, houses are built there, and the army corps of engineers subsequently builds the dams and levees.
3 Comments
Julien Couvreur says:
This is a great point. One intervention (setting the precedent that government bails out some people) invites more mistakes, which government then wants to control. The process actually goes on further: an agency now has to define what is prohibited (which areas, which types of constructions, etc), which people will try to game and/or lobby. That will lead to further intervention and side-effects. It is a slippery slope of intervention begetting further intervention.
Incidentally, the same thing happened in the financial sector (bailouts and government “insurance”), which invited irresponsible risk, which then needed to be constrained (a battle regulators tend to lose).
3rd of December, 2012John Seiffer says:
I think the term for this situation is “moral hazard” when a person is encouraged to take risks because the downside of those risks will be borne by someone else.
4th of December, 2012Andrew Rick says:
Its outrageous, when we bought our new house 7 years ago at no point were we told it was adjacent to a flood plain, where other houses are also built by the same builders. The floods two years ago were awful. We lost so much, we now cant get insurance for flood. The government allow this building program to happen, they have a duty to protect us. We now live in fear when its rains. I have been onto the comparison websites but no one is willing to quote. Is any one else in this position? What can we do about this?
13th of December, 2012