Friday, September 16, 2005

Hedging, hucksterism and Hood


It was only a matter of time before the Gulf Coast disaster moved from the finger-pointing stage to the pocket-picking phase. President Bush's speech from New Orleans last night will go down in history as the pivot point of that transition, but it was in Mississippi, earlier in the day, that the tone was set when State Attorney General Jim Hood filed suit against several insurance companies.

Hood's contention is that Mississippians who bought insurance policies really didn't know what they were buying, and that they are therefore somehow due compensation for damages they didn't pay their insurors to cover. Specifically, Hood holds that even though many insurance policies exclude water damage, Mississippians are too stupid to know that those exclusions apply to water damage caused by, say, Hurricane Katrina.

As populist demagoguery, Hood's move makes perfect sense -- but it's flat-out wrong and immoral, and if he succeeds (possibly even if he fails) the consequences will be dire for all involved. In the short term, insurors will lose big bucks paying out on illegitimate claims and their customers nationwide will eventually take the hit in increased premiums. In the long term, Mississippi's families and businesses will find it difficult or impossible to insure their homes, cars and enterprises. Hood the Huckster may benefit politically from this kind of stunt, but nobody else will come out ahead on the deal.

Let's call insurance what it is: Gambling.

When you buy an insurance policy, you're making a "hedged" bet. You're betting a small amount of money that you'll suffer some kind of damage. If you do, the bet pays off and you get compensated for that damage. You don't want to win the bet of course. It's just a way of minimizing risk. Better to pay out $100 a month on a "losing" bet than to unexpectedly "win" the $100,000 pot and not have a bet on the table.

The insurance company, on the other hand, is betting that you won't suffer the damages it's committed to covering. They take your $100 a month, month after month, and only have to pay out if your house burns down or your car gets t-boned by some idiot who runs a red light.

As always, the house -- be it a casino or an insurance firm -- keeps an edge. They calculate the odds and set the premiums such that, on average, they win more than they lose, i.e. they take in more in premiums than they pay out in claims. Sure, they may lose big on some policies, but they win small on enough of those policies to cover their payouts and take a profit.

Yes, a profit -- you didn't think that insurors were in it for the purpose of dispensing charity, did you? Insurance is a business. If a business doesn't make a profit, it shuts down ... which helps nobody, as you no longer have a place to plunk down your hedged bet.

The government of Mississippi, in the person of Jim Hood, is trying to cheat the house -- to change the terms of the bet after it's been made, or to past-post -- to move the bet after the outcome of the game is known.

Life entails risk, and one of the risks of living on the Gulf Coast is that every so often a big storm is going to come through sweeping you, yours and everything you own in front of it. Hedging one's bet against such an eventuality made sense. As a matter of fact, it made so much sense that two things happened:

- The insurance companies decided, for the most part, that covering that particular bet wasn't something they wanted to do -- so they excluded those conditions from their policies.

- The federal government decided that covering that particular bet was imperative -- so they offered subsidized flood insurance for people living in areas of high risk, including Mississippi's Gulf Coast.

Many Mississippians made poor choices. They declined to buy the cheap, government-sponsored insurance, and they either didn't pay attention to what was in their regular policies or decided to shoulder the risk themselves instead of paying more to have it shouldered by someone else. Now they're screwed ... and whatever the solution is, it most manifestly is not to force insurors to pay off bets they never made to folks who never anted up.

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