Restless modern minds have developed some new approaches to risk. These examples of thinking “out of the box” will eventually end up back in the box – as case studies in business schools across the country: “Risk Management For Dummies – and we really mean dummies!”
NINJA Mortgages
Let’s begin at the micro level: the collapse of the sub-prime home lending businesses, one bad mortgage at a time. This once hot market gave rise to some interesting schemes, none more absurd than what Steve Pearlstein of the Washington Post dubs “the NINJA mortgage” – no income verification; no job verification; no asset verification. You walk in with empty pockets, you walk out with a mortgage. Why didn’t I think of that?
Of course, the mortgage starts out at a very low rate, one that even the NINJA householder can handle. After a year or two, however, the rates go up – way up. The homeowner (and I use that term advisedly) defaults, so the bank kicks them out and takes over the loan. Unfortunately, the value of the mortgage (issued at the peak of the market) exceeds the value of the house. As any good accountant will tell you, these numbers simply don’t work. The once proud homeowner is forced to become a tenant; and the once proud lender (did someone say “New Century“?) skips the first ten chapters of the morbid story and heads straight for Chapter 11.
Florida’s Insurance Shingle
Which brings us to some foolish thinking on a much larger scale, a scale as big as the state of Florida. Water views – the state’s greatest asset – have become, with global warming, something of a liability. We are less than two years removed from the worst hurricane season in history, with three of the most destructive storms on record hammering the state’s extensive coastline. Property insurers have gotten skittish. They want more premium for the risk of writing coastal property. But higher premiums make homeowners and politicians unhappy. While there’s not much a homeowner can do, politicians could do a lot: they could tighten coastal zoning regulations. They could severely limit coastal development. They could establish barriers between the open ocean and development. They could raise construction standards. They could, but of course, they won’t.
No. The first thing the politicians did was roll back the insurance rates. They put a couple of hundred bucks in the pockets of voters — oops, I mean homeowners. Take that, Property Casualty Insurers! Then in its infinite wisdom, the legislature jumped head first into the property risk business. With a mere $1.9 trillion in coastal property exposure, the state has decided, essentially, to self-insure. That is, the state is underwriting future losses through future bonds. If another big one hits, the state will finance recovery by borrowing. How will they pay for the loan? Simple: by adding a surcharge to every business, auto and homeowner policy written in the state. It might cost the average homeowner $14,000 or more over the life of the bond, but at least they have a couple hundred in their pockets right now.
Unlike conventional insurers, who try to set aside adequate reserves to cover future losses, Florida has entered the gray zone of post-event funding. I suppose it might even work for a modest storm. But what about another major hit like Katrina – or, dare we think, two or three major hits? (I know. I’m a Nervous Nelly. With this country’s pro-active, can-do approach to global warming, these hypothetical risks will remain…hypothetical!)
If you’re interested in exploring the implications of Florida’s Brave New Risk Retention program, Towers Perrin has a nice study here. They are careful to avoid any value judgments. They call their paper “a study of recent legislative changes to Florida property insurance mechanisms.” I’m inclined to give it another title: Blowin’ In the Wind: Florida Stakes its Future on Loaded Dice.
