Commentary: Don't Subsidize Castles Built On Sand

Hurricane Floyd did more than smash real estate. It will also shake up bank accounts from coast to coast. By the time the cleanup and rebuilding are complete, all U.S. taxpayers will have anted up for Floyd through big payouts on subsidized flood insurance as well as grants and low-cost loans to people living in federally designated disaster areas.

It's admirable for people to lend a hand to neighbors who are in distress. Unfortunately, in most natural disasters, much of the public money goes to cover losses that could easily have been avoided. Government policies thwart sensible behavior. They make it too easy for people to live in beautiful but disaster-prone places such as barrier beaches, flood plains, cliff sides, tinder-dry canyons, and seismic fault zones. That's one reason why financial losses from natural disasters are growing at a rate faster than the economy itself is expanding.

FORGIVING TIMES. The solution isn't some elaborate new government disaster-relief program. Quite the opposite, in fact. In most cases, the best thing the government can do is get out of the way and let the free market do its work. That requires a well-functioning insurance market, one in which premiums are correctly aligned with risks. Subsidies make people do dumb things because they don't pay the full consequences of their behavior. "You don't build a house on train track...and you shouldn't build 10-story buildings on sand dunes," says Brett D. Hulsey, director of the Sierra Club's Protect Our Families From Floods Project.

The free-market approach to disaster preparedness and relief works when it's given a chance. In 1982, for instance, Congress passed and President Reagan signed the Coastal Barrier Resources Act, which mandated that 1.2 million acres of vulnerable private land along the coasts would not be eligible for flood insurance or government-funded roads, sewers, or beach replenishment.

In other words, you can still build a mansion on your dune, but when it gets washed away, you won't be able to hit up the taxpayers for a new one. That discourages imprudent development. Quips Jacqueline Savitz, executive director of the Coast Alliance: "If we don't rebuild it, they won't come."

A free-market approach isn't just for preserving pristine beaches. It also works in places that have already been developed. Take Florida. Homeowners insurance became nearly impossible to get in the Sunshine State after Hurricane Andrew in 1992, and the state had to step in with subsidies.

However, after studying computer models of potential storm damage and reviewing property values, insurers realized that most of the state was still a good bet for subsidy-free insurance. The insurance companies have raised premiums, increased deductibles, and capped coverage while building up their reserves and laying off more of their risk on reinsurers. So despite the state's infamous vulnerability to storms, you can still insure your home in Florida--you just have to pay more to do so. That makes sense.

In some cases, of course, the only sensible thing is to move out of harm's way. Since 1993, the Federal Emergency Management Agency has helped relocate more than 11,000 homes and businesses along the Mississippi and other rivers that are prone to repeated flooding. That's a giant step forward from the traditional practice of building higher and higher levees, which inevitably break.

HINT, HINT. Still, there is more to be done. James Lee Witt, the iconoclastic director of FEMA, advocates denying subsidized federal flood insurance to people who make repeated claims and refuse to take preventive measures, ranging from sealing their basements to raising their houses on stilts. A version of the proposal was introduced in the House of Representatives this summer as the Two Floods and You Are Out of the Taxpayer's Pocket Act. Meanwhile, the Coastal Barriers Act is up for reauthorization. There is a move afoot to exempt certain areas, such as pieces of Florida's Gulf Coast and North Carolina's Cape Hatteras. Instead of being weakened, the act should be expanded to cover more vulnerable areas.

It may seem cold to focus on money when hurricane victims are still picking through the rubble of their homes. In fact, though, a revamped disaster-insurance program would not only save money, it would save lives. With the proper incentives, people will choose to live in safe homes on safe ground. And everyone will benefit.

    Before it's here, it's on the Bloomberg Terminal.