Friday, June 18, 2010

We Are All Tony Hayward

In case you've been under a rock, or an oil slick, Tony Hayward is the embattled head of BP.  And no, I am not about to attack you and your carbon footprint or personal oil consumption.

Richard Epstein writes in the Wall Street Journal yesterday that BP should not have liability caps:
A tough liability system does more than provide compensation for serious harms after the fact. It also sorts out the wheat from the chaff—so that in this case companies with weak safety profiles don't get within a mile of an oil derrick. Solid insurance underwriting is likely to do a better job in pricing risk than any program of direct government oversight. Only strong players, highly incentivized and fully bonded, need apply for a permit to operate.
Basically, if you have everything to lose, you act more responsibly, and you buy more insurance.  (And, your non-"catastrophic loss scenario" return on equity falls.)

In seemingly unrelated news, the GAO released its latest report on individual state natural catastrophe programs.  (Here's the summary, and the full report.)

For me, the highlight of the report: Florida's hurricane programs cover $2 trillion of risk.  Yes, that's trillion, not billion.  I am not making this up.  How do you imagine the state of Florida covers that risk?  You and your wallet.  I've written about this before, whether it's a special program to bail out all our high risk friends, or the lunacy of making the money losing National Flood Insurance Program cover hurricanes too.

So, Epstein argues that liability limits amount to free insurance.  If you know you can't pay out over some limit, then insuring about that limit comes at a price of zero.

Too many people will argue that without liability limits, or without free insurance from the government, "companies won't function," or "homeowners can't live."  That's just not true.

However, I have two questions that maybe I'll investigate further, and I'd love Epstein's thoughts:
  • Why do we have limited liability companies because that too amounts to free insurance?
  • How do you avoid private insurance and reinsurance companies becoming systematic-disasters-waiting-to-happen because, as I argue here and here, they cannot possibly hold capital to cover their risks?

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