I admire SA independent senator Nick Xenophon hugely. He’s a rare combination of brains, enterprise and principle. I knew him at Adelaide University; he had all those qualities then, and he seems to have kept them intact over the quarter-century since.
But I have wondered for weeks why he is so keen to have the states insure against natural disasters.
Today I may have found the answer to my puzzle. Xenophon is being advised by former insurance industry executive John Tsouroutis. When Malcolm Farr profiled Tsouroutis in a recent article for The Punch, the picture emerged of a bloke who thinks outside private insurance is always good.
This seems to me exactly wrong. At a government level, outside private insurance is almost always bad.
Before we go any further, it pays to remember that insurance only spreads risk rather than eliminating it. Remember also that private insurers need to make profits. (I make these obvious points here only because they seem to have disappeared in the debate over state insurance.) Insurance is likely to cost you more than not being insured. You don’t insure to save money. You insure to avoid unlikely episodes that would cause you too much stress to fund yourself when they happened. For instance, you insure your family against the chances of its principal breadwinner being killed or disabled, because your savings won’t cover the costs of this sort of unlikely but potentially devastating blow.
So I was startled to hear that many state governments currently take out natural disaster insurance. As a general principle, governments should not insure against Bad Things, be they floods, bushfires or earthquakes – or, for that matter, recessions. Not only should Queensland not take out such insurance, but the other states should stop doing so.
And here’s why:
- Insurance works best when it covers events which would overwhelm you if they happened. For a government, a $7 billion disaster like Yasi is big, but hardly overwhelming. Queensland is a $250 billion economy, and the state government brings in revenue of more than $37 billion a year. Pre-disasters, the Queensland government was projecting deficits of more than $3 billion for 2010-11 and 2011-12, due to the impact of the economic slowdown. Borrowing to pay $7 billion for Yasi would add another $0.5 billion a year to that figure at most – large, but manageable at less than 2 per cent of overall expenses. If you want Queensland to insure against huge blows to its economy, forget cyclones – get the state to buy insurance against recessions.
- Insurance works best when it covers unlikely events. In Australia, natural disasters do not fall into this category. For the people being hit by them, cyclones and bushfires are frequently once-in-a-lifetime events. But for governments, over the course of a decade or so, some sort of disaster is statistically likely. We’re a nation of droughts and flooding rains, not to mention bushfires and cyclones. We know this stuff happens. If we’re smart, we’ll have our governments put aside some money for that rainy day.
And of course, sometimes disaster is not even completely surprising to the people it’s happening to. The north Queensland coast, for instance, attracts cyclones like a summer evening barbecue attracts mozzies. That’s why when Cyclone Yasi hit, the locals kept comparing it to the recent Cyclone Larry.
- Insurance works best when it covers events that are out of human beings’ control. For individuals, catastrophic health problems are like that. Cyclone, flood and bushfire damage are not always avoidable, but their costs can be minimised, for instance by not building flood-vulnerable buildings in flood plains and by building for high wind resistance. Insurance acts as encouragement not to worry about the things you insured against – a problem known as “moral hazard”. A government insured against flood losses will be more likely to unwisely allow flood-vulnerable building in a flood plain, and to ignore or (more likely) under-fund flood mitigation efforts.
Private insurers deal with this moral hazard by jacking up their premiums. A government insuring against floods will likely end up paying a private sector premium to escape the consequences of its own expected inaction and short-term lack of will.
- Governments possess vast abilities to tax and borrow. If they won’t put aside money to cover the costs of a natural disaster, their next best course is to raise the money after the event, not to insure. Their funding costs are probably going to be lower than the insurer’s borrowing costs.
(Note that on these arguments, smaller governments may have a case for outside insurance. This might help explain the perspective of John Tsouroutis, Xenophon’s adviser; he most recently ran the Northern Territory government-owned insurer, TIO.)
For most governments, the best insurance against floods, bushfires, earthquakes and recessions is four-fold:
- Implement good policy. Minimise building in floodplains where floods would destroy the buildings’ value. Create anti-cyclical policies which lessen the boom-and-bust cycle. And so on.
- Build government rainy-day funds. You can call your fund a Future Fund, a sovereign wealth fund or just a really big budget surplus. At a state level, it will guard against bushfires, floods, cyclones, earthquakes and other blows. At a national level, it will guard against the day when the banks threaten to collapse, the Chinese stop buying steel, or the commercial property sector suddenly loses faith.
- If a big natural disaster comes along at a time when a government needs to be tightening fiscal policy anyway, a disaster levy makes sense, even though it is somewhat opportunistic. Right now, a levy makes sense. If the Queensland floods had hit two years ago, in contrast, the best reaction would have been government borrowing.
- Don’t pay for private insurance.
Who stops this happening? You could blame a lot of people – governments, self-interested private insurers, and so on. And Senator Nick Xenophon and his adviser sure aren’t helping matters.
But the real blame lies with people who constantly protest the sight of a government Budget in surplus, and people who forget that over the course of years, bad things always happen and need to be paid for. In short, the people who most need to take a longer-term view are voters.