Most people in the world do not have insurance against earthquake risk. Now that seems almost astonishing because the risk is so well quantified and there's such an incentive to manage the risk. So this is a picture from the Haitian Earthquake of 2010. And you can see the damage it caused and yet most people there were not insured. So the earthquake came in 2010, before the earthquake there was the movement that tried to get Caribbean countries to buy insurance. And so they did so only a little bit. The Caribbean catastrophe risk insurance facility, manage to a create about $8 million of loss insurance. [LAUGH] But the loss is from Haitian earthquake reached into the billions. So why weren't the Haitians insured? There was an organization trying to get them to do it and they could have bought it. But apparently, there was a resistance a thought that maybe a mistrust of institutions, a tendency to believe in good luck or something like that. Here's another example. Hurricane Katrina is 2005. Now, this is in the United States where people are much more sophisticated, I would say, or at least attuned to financial solutions. So the city of New Orleans was heavily damaged in the Katrina hurricane. But again if insurance wasn't perfect there as well. So now this is totally different from Haiti because we have a lot of insurance in the United States. There was in fact losses of $34 billion caused by the hurricane. And these were settled and paid out. But there were problems then, again, the problem was that a lot of the insurance policies were insured against wind damage, but not flood damage. Now, before the fact, when you sign the insurance contract, this might seem like a minor distinction. Because Hurricane Katrina was both wind and flood. But many of them did not have flood insurance. Now why didn't they? Maybe they couldn't imagine how can it flood here in New Orleans? They didn't understand the impact that a hurricane can have. So also maybe because of global warming and greater fears of hurricanes, the insurance companies had been raising their rates on hurricane insurance. So many people in New Orleans had cancelled their insurance because they thought it got too expensive. So there was this substantial failure to compensate people in New Orleans as well. Not as bad as Haiti. You're saying why should I buy flood insurance if I just say I didn't do it sorry I'm I've made a mistake someone will come and help me. And so I'm going to build the house on a flood plain anyway because I don't care. Now, that was a problem. When they passed the National Flood Insurance Act in 1968, people didn't just go and buy it. They were ignoring it. So one thing that, later, Congress, in 1973, passed another act that made it mandatory to buy. It wasn't a choice anymore. You had to buy the insurance. If you were building in what was a designated high-risk area. On top of that, the US government has tried to tell you, we are not going to help you that much. If you didn't buy in areas where it wasn't mandatory, if you didn't buy flood insurance, the government will limit their help to loans. So okay, you're house was washed away in a flood. You didn't buy flood insurance. Well, we're not going to just forget about you, we are going to lend you the money to build another house. So the government is there but it's not helping you that much. So they're trying to create a system with the right incentives and the bottom line is, stop building in flood prone areas. And if you do make the mistake, you will only get minimal help. And you better know that when you build a house. Some people disregard everything. I'm sure it's still happening, but it's kept down to a small number. I think this is one of the wonders of modern capitalism that we do as well as we do. And then finally we want to talk about terrorism risks. Insurance policies have in the past generally not focused on terrorism risk. Before 9/11/2001, most insurers did not exclude terrorism risk because they didn't think that it was even a risk. But after 2001, they started changing their policies to say we don't cover terrorism. This led to a sense of frustration that this is a big risk that people are suddenly concerned about, and they can't by insurance against it. For the insurance company, said that this isn't the way we do business. We don't insurance against correlated risks like that. There could be a huge terrorist attack, and how do you expect us to pay it out? In this case, this is an example where the government plausibly becomes involved and has been involved in history as well in providing the insurance against the acts of war. Because the insurance companies can't do it by themselves. So in 2002, the United States Congress passed the TRIA, the Terrorism Risk Insurance Act of 2002, which required insurers to offer terrorism insurance for three years. But the government would pay for it, or at least 90% of it. Because they decided it was too much of a tax on the insurance company, to asked them to bear this risk. And what were they charged for? That's the thing because they don't know where it's going. So the government agreed to pay 90% of the insurance industry losses above a $100 billion. So that act keeps expiring and keeps being renewed again. So by 2015 the act was renewed again until 2020. But you think they should just make it permanent, right? Why is it a temporary thing? It reminds me of bankruptcy law. In the 19th century, if you went bankrupt, let's go back to 1800. If you couldn't pay your bills in 1800, they had special prisons for you called debtor's prisons. But there were repeated financial crises through the 19th century. And, A lot of people went to debtor's prison who were perfectly innocent. The only crime they're guilty of is not understanding that they would lose their job in a financial crisis and they couldn't pay. And their company would say, it's something like that. It's not really their fault. It's not something we want to see punished by jail. So in the 19th century, whenever there was a financial crisis, they passed some special bankruptcy law that had a time duration like this and expired. They thought, well, we're just dealing with the current crisis. But as time went on, these crises kept coming and eventually, bankruptcy law became a permanent fixture, not just a reaction to a crisis. So that's probably what should happen to TRIA eventually. There are certain things that are hard to insure. And we require the government to come in to do the job. We'll come back to that when we talk about public finance later.
