Sunshine on my (and your) shoulders

By DAVID MOON, Moon Capital Management
October 31, 2004

The next time you go to the beach, get a home magazine and look at the prices of the prime waterfront properties. Now imagine the fairness of you unknowingly subsidizing the price of a $2 million vacation home.

An executive from Allstate recently appeared on CNBC, explaining that the company's huge decline in third quarter earnings was due to this year's devastating hurricane losses in Florida. When asked if Allstate planned to pull out of the seemingly meteorologically jinxed Sunshine State, he made the case for a change in the structure of homeowners' insurance. 'There has to be a new model of risk sharing ' determining how much of the risk will be assumed by private insurers, the state and the federal governments. It should be much like flood insurance.'

In other words, everyone should share the costs of rebuilding expensive homes built in inherently dangerous locations.

The National Flood Insurance Program (FLIP) provides insurance for structures located in flood prone areas. According to a 2001 Congressional Budget Office report, FLIP policyholders pay only 38 percent of the actual cost of the insurance they receive. Federal taxpayers (that includes most people who read this page) pay 62 percent of the cost of this coverage.

The market price of buildings located in flood-prone property is artificially inflated because the owners don't have to bear the full cost of ownership. A hurricane insurance program like the FLIP would cause more every day, middle class Americans to subsidize the cost of expensive waterfront property. Many of these types of homes are out of the price reach of average Americans - in part because their own federal tax dollars are being used to inflate the prices.

In a June 2000 report, the Federal Emergency Management Association reports that close to 87,000 homes and buildings have been built on land that is likely to wash away during the next 60 years. Many of these are expensive vacation homes, out of the financial reach of most Americans. Yet most Americans are subsidizing flood insurance for these often wealthy landowners.

There are thousands of homeowners who have intentionally and knowingly built homes that will probably suffer known, expected catastrophic damage, yet those homeowners don't have to worry about the risk of their house washing away in a flood; the federal government pays most of the cost of insuring that risk. These are the types of home sites that are already attractive, because they are on the water, with nice views and other natural amenities. Potential buyers are willing to pay higher prices for these homes, partly because of the adjacent water features, but also because the home prices are held artificially lower by a taxpayer subsidy.

Would the federal government provide subsidy and loss indemnification for new buildings erected on the peak of a volcano that was about to erupt? Should a hurricane-prone location be any different?

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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