Regulatory plumbing and insurance pricing

Insurance pricing winds up a mess when the government leans on insurers to not price insurance fairly. 

Minister Robertson last week admonished insurers not to use more granular pricing in ways that would leave some parts of the country uninsured or 'uninsurable'.

Currently, people who live in low risk places cross-subsidise people who live in high risk places. This happens explicitly through EQC, which does not risk-base its prices for coverage. But it also happens implicitly when the state either hints or (now) shouts that it'll come down hard on the industry if prices are set to reflect risk.

And it then all causes a mess.

In the absence of the regulatory shadow, we'd expect one of two things to happen. Either insurers would start offering cheaper insurance deals based on granular data on actual risk, or a new entrant would come in and cherry-pick the safer parts of the country for insurance deals, with prices that reflect actual risk and no cross-subsidy.

Instead, while prices in Wellington are higher than more stable prices, prices between risky places in Wellington and safer places is flat.

This will cause distortion, encouraging too many people to live in places that are relatively risky. Fair premiums would see higher insurance costs in places like Petone.

I hit on these problems in this week's column in the Fairfax papers, reminding of the consequences of inviting the Three Stooges to do your plumbing. I stole the analogy from Pete Boettke - thanks/sorry Pete.

There was a great old The Three Stooges bit about plumbing that teaches us a lot about regulation.

The Stooges were a trio of hapless idiots who produced comedy gold in the days before colour television. In 1940's "A Plumbing We Will Go", the team tried to fix a leaking basement pipe – not much noticing the damage their repairs were causing to other pipes, to the ducting, to the floors, and to the wiring.

For all the plumbing work, the basement just wasn't getting any drier — and the rest of the house was wrecked. Regulation is too often like that, creating multiple new problems for every problem it tries to solve, and a never-ending cascade of regulation trying to patch the leaks caused by the prior rounds.
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Failing to price risk properly also makes councils want to restrict development in riskier places – even for people would have been willing to pay high insurance premiums.

The whispered answer I'll usually get on asking around is that insurers worry that they would be stomped on by central government if they allowed home insurance premiums to reflect risk.

Insurance prices in places like Petone would skyrocket. People would complain to the government.

Government would respond – and probably poorly. Insurance would look unaffordable to too many people – and especially if people started betting that higher rates of uninsurance would mean the government would bail them out come the quake. Both of those concerns would have the government step in to regulate insurance charges.

This kind of worry never seemed implausible, but it always seemed a bit hard to prove. But, Finance Minister Grant Robertson warned insurers last week that they should not allow risk-based premiums to result in insurance unaffordability in risky places.

And we're back to the Stooges and plumbing. If insurers price risk properly, they'll be in trouble with Robertson. If they don't, councils will increasingly look to zoning to undo the mess. And that causes cascading sequences of additional problems.

We should be careful when asking government to turn regulatory wrenches. Government plumbers too often fail to notice the other pipes they break along the way.

The Three Stooges - "A Plumbing We Will Go" (1940) from daniel lansing on Vimeo.