Monday, April 09, 2007

Federal Hurricane coverage and Cross Subsidization

The following article provides a nice, albeit journalistic, overview of pros and cons for a national catastrophe "backstop" fund.

The REcapitulator would only wish to remind his readers that such a fund, in economic terms, amounts to a massive cross subsidization from states that have little or no natural disaster exposure to states like Florida.  This is precisely the sort of "noise" that has no clear "diode" (keeping with the circuitry analogy) for markets to efficiently allocate available capital.  The following excerpt from the article is on point:

"While natural disasters may occur in any state, Nutter noted, most are economically modest. He also said 97 percent of all earthquake losses were in California and 75 percent of hurricane losses since 1900 were in Florida, Texas and Louisiana."

Another issue is, of course, pricing.  The Federal coverage would ostensibly cover for mega-catastrophic risk.  The REcapitulator is skeptical of any governments ability to price this
coverage in a way that optimally transmits information about the risks of mega-catastrophes.