How you in Indiana subsidize Florida beach mansions

Here in Bermuda this weekend’s Hurricane Igor has already been forgotten. It was the largest hurricane in recorded history in the Atlantic, as measured by diameter of hurricane winds. It made an almost-direct hit here. Yet a few hours after the storm ended the island was pretty much back to normal. Amazingly there was not a single storm-related injury. We watched the Weather Channel's Jim Cantore breathlessly report on “major structural damage”, or 2 cottages at a downscale cottage colony. Back in the States, today the US Senate approved extending the money-losing National Flood Insurance Program (NFIP) by another year.

It got me thinking about the role of government in preventing disasters. Bermuda gets struck with a hurricane, most people ride it out at home, and there’s virtually no damage. In contrast the US suffered $10 billion of damage by each Hurricane Rita and Wilma in 2005. Not to mention the $45B in damage from Katrina, which put NFIP in a $19B hole that taxpayers will eventually pay. Even a quick drive along Lake Michigan shows houses just a single big storm away from falling in the lake. Now think of how you're on the hook for insuring over 4 million such houses up and down the coasts.

One way to reduce damage from storms is to use building codes to regulate away all but the strongest of building techniques. Then it wouldn’t matter nearly so much if government subsidized socialized insurance like NFIP. The opposite approach would work too: let people build their houses wherever they wish, out of whatever materials they like, and pay their own private-market insurance. No more government insurance programs for beach houses. The private insurance market will price the risk, and only a fool who wants a massive homeowners insurance bill would build a house of wood on a barrier island or beach.

Unfortunately, since 1968, federal government has insured about 5% of the homeowners market through NFIP. State “wind pools” and “beach plans”—most of which are not financially sound--cover another 6% of the ~$75B US homeowners insurance market. NFIP takes in about $3B in premiums a year and currently has a $19B deficit. While we midwesterners tend to think of NFIP as covering the guy who lives in a van down by the river, about ¾ of its claims are for hurricane damage. These government programs, which underprice risk and leave taxpayers on the hook, encourage building and rebuilding on sites that are almost surely to become major losses in a storm.

Bermuda has no such government insurance program, so anyone building a house on the ocean had better find an insurer willing to cover it else bear all the risk of loss. Bermuda also has strict building codes requiring homes to be made of concrete with white stone-and-concrete Bermuda-style roofs. Houses must also not be built directly on the beach, where they’re easily vulnerable to storms. No wonder people “ride it out” and emerge 48 hours later with essentially no damage. Proposals for hurricane-tough building codes have had a very mixed record of success in the US, but one wonders if they’re even necessary or if the private insurance market can provide better discipline through their underwriting practices.

The libertarian approach could well work in the US: let people build wherever they want (unlike Bermuda), but eliminate the government insurance programs that subsidize building on beaches. If you want to build on the beach, build whatever you want, then find someone to insure it and don’t expect the government to bail you out if it gets washed away. We’ll find that not only will hurricanes be a less serious problem, but taxpayers who live far from oceans won’t be on the hook to subsidize fancy beach houses.