Affordable Housing Institute : US

In previous blog posts I have emphasized that New New Orleans’ creation will depend on factors both tangible (the water line) and intangible (the insurance line).  Now, judging by this recent Washington Post article, we may find that the two overlap:

 

NEW ORLEANS — Many of the thousands of homeowners in the Lower Ninth Ward, one of the hardest-hit areas in the city, lacked flood insurance because the neighborhood in theory was supposed to be relatively safe, local insurance agents and residents said.

 

Most of the area sits outside the “high-risk” flood districts designated on federal maps used for insurance, and so, unlike homeowners elsewhere in this low-lying city, most in the Lower Ninth Ward were not legally required by lenders to buy flood coverage.

 

What duty does the government have to its citizens? 

 

 

Dennis Rowan Sr., with wife Antoinette Rowan, covers a door with plywood at the home of his wife’s aunt in the Lower Ninth Ward of New Orleans. Although many of the neighborhood’s residents lack flood insurance, the aunt had a policy. “I don’t know what we’re going to do,” one resident said. [Very curious of the WaPo to illustrate a story about insurance gaps with someone who bought the insurance! — Ed.]

 

Does that duty change after disclosure and informed choice?  An economist would say that those who make an informed choice should live with the consequences of that choice, because otherwise the government is vulnerable to moral hazard (people taking foolish risks because they are convinced, despite all denials, that someone will bail them out).

 

In communities all along the Gulf Coast, the shape and extent of the recovery — or neighborhood abandonment — may depend largely on who had flood insurance and who did not.

 

Hurricane Katrina was one of the most destructive storms to strike the United States in 50 years. Now some insurance experts say it is likely to be the most difficult from which to recover because a relatively small portion of the economic damage is covered by insurance.

 

What if the choice not to obtain flood insurance was not truly informed, or worse, mis-informed? 

 

Among the key factors determining whether a homeowner buys flood insurance are the complex maps created by the Federal Emergency Management Agency and adopted by communities.

 

Banks are supposed to require that borrowers have flood insurance for homes that are inside designated “special flood hazard areas.”

 

Insurance remains the curious bet: you bet something awful will happen, while the insurer bets it will not.  Though based on experience and projections, in the end, it is nothing more sophisticated than a bet:

 

About 61% of single-family homes in such areas in the South are covered by flood insurance, according to a Rand Corp. analysis cited by the Insurance Information Institute.  By contrast, outside those areas, only about 1% of property is covered.

 

Though Alfred Korzybski said the map was not the territory, these maps have thus had the effect of shaping customer behavior (1% versus 61%) and financial exposure. 

 

Most of the Lower Ninth Ward and much of neighboring St. Bernard Parish, which was also hit hard, were not designated flood hazards because the risks were determined by calculating how much rain would accumulate on a given property in a “100-year storm event.”

 

The mapmakers took into account ground elevations and pumping capacity in neighborhoods, but they assumed that the levees would hold and that neither the Mississippi River nor Lake Pontchartrain would spill in.

 

“As you can plainly see, the water will not be held back by the levees.”

 

If the maps were flawed, suddenly the question of who pays becomes more complex

 

Those federal insurance maps, however, were based on a vastly mistaken assumption: that the levees and flood walls protecting the neighborhood from inundation would remain intact.

 

When the levees breached near the Lower Ninth, the floodwaters ravaged countless homes unprotected by flood insurance, and many neighbors wonder whether anyone will have the wherewithal to rebuild.

 

Then the maps should have been correct, says the indignant reader.  But now consider this:

 

If flood insurance regulations had not assumed the levees would hold, every new building would have had to be built as much as 15 feet off the ground.  That would have made new construction ungainly and much more expensive.

 

I’ve fiddled with the Post’s prose to make the point clear: Stakeholders benefited enormously from the levee-hold assumption.  Underwriting construction that was levee-failure-tolerant would have imposed a very large surtax on anyone who wanted to build property in New Orleans.  The stakeholder outcry would have been enormous, with complaints about ‘unrealistic engineers,’ ‘excessive Federal regulation,’ and ‘unfunded mandate.’ 

 

I know.  I’ve heard such screams many times when doing the operating budgets for affordable apartment properties that may or may not be within fifty-year or hundred-year flood plains.

 

“It’s not a simple subject,” said Michael Buckley, deputy director of FEMA’s flood mitigation division.

 

The ambiguity over whether anyone will pay flood insurance to those who lacked it is paralyzing some redevelopment:

 

While some lawmakers talk about relief for the uninsured, no one is sure what will happen, and the uncertainty in the Lower Ninth Ward breeds household fears.

 

Our caricature of an insurance salesman is someone who sells you too big a policy covering too remote a risk. 

 

 

“Tell your customers not to buy any insurance, they don’t need it!”

 

Here we have the reverse: people who were chose not to buy a policy that they now all wish they had:

 

Robert P. Hartwig, chief economist at the Insurance Information Institute, an industry group, has tallied insurance payouts after natural disasters in the United States, Western Europe and Japan.

 

On average, private insurance covers 62% of the economic losses after natural disasters in those places, he said. But in New Orleans, he expects that insurance will cover less than half of the losses — and perhaps much less than that — because of the magnitude of uninsured flood losses.

 

“It will probably be the lowest percentage of coverage for a major natural disaster in the U.S. for the last half-century,” Hartwig said. “Unfortunately, the level of coverage in New Orleans is likely to be somewhere between the Western countries and the Third World — where places can be affected for years, if not decades, by natural disasters.”

 

Is it just New Orleans, or more of the nation?

 

“It’s not just New Orleans,” said Steve Kanstoroom, a pattern-recognition expert who has brought FEMA problems to Congress’s attention and organized a Web site on the issue, http://www.femainfo.us/ . “People are in harm’s way all over the country and they don’t even know it.”

 

Katrina was too improbable to insure.  But now it has happened.  Now what?

 

Private insurers are expected to pay about $40 billion in Katrina damage, Hartwig said. The flood insurance program will kick in billions more. But total Katrina damage has been estimated at $125 billion, and Hartwig said that figure is probably too low because the interruption of business is only partially included.

 

Who or what fills the $85 billion hole?

 

 

Don’t look for Scrooge McDuck to fill it …

 

It’ll take me a couple of days to write the proper post dealing with the issue.  In the meantime, I’ll leave you with this poser:

 

There are some risks it is not cost-effective to insure.  Hurricane Katrina was one of them.

 

So what happens after one of those uninsurable risks happens?

 

[Previous posts on New Orleans here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, and here.]

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