Moral hazard has become a way of life for many people living in Florida or Texas.
They accept the risk that monster storms such Irma and Harvey may one day reach their doorstep because they know the government has their back. Every time a storm lashes the coast, governments predictably pay out billions of dollars in disaster relief and subsidized flood insurance.
By underwriting a big chunk of the risk of living in storm-prone coastal areas, governments have turned natural disasters into tax payer catastrophes. It has created a dangerous cycle of build, subsidize and rebuild, with the benefits flowing disproportionately to wealthy homeowners.
Think it can't happen in Canada? Think again.
Relatively few hurricanes make landfall in Canada, but destructive storms, and particularly floods, are becoming a growing financial headache for Ottawa and the provinces.
Ottawa's Disaster Financial Assistance Arrangements program – the country's primary source of disaster relief – has quietly become a money pit. A few decades ago, the program barely registered as a blip in the massive federal budget. By the late 1990s, the program had grown to hundreds of millions of dollars a year.
The annual tab going forward will soon hit nearly $1-billion due to "an increasing number of large weather events with greater intensity," according to a 2016 report by the Parliamentary Budget Officer. The PBO estimates that the federal program's cost from weather events will average $902-million per year, with flood damage accounting for three quarters of the bill.
Ottawa is essentially underwriting a growing chunk of disaster risk.
Large catastrophic losses are becoming more frequent. And flooding is largely to blame. Widespread floods in Ontario and Quebec this spring offered a hint of what lies ahead.
Five to 10 per cent of Canadian homes – 500,000-plus in all – are located in areas at high risk of flooding, according to flood mapping by the insurance industry. That makes them virtually uninsurable, and unprotected.
Until recently, Canadians could not buy insurance for overland flooding, at any price. Now roughly 15 companies offer it. But protection is often limited, or prohibitively expensive ($1-million of coverage for $18,000 a year with a $100,000 deductible, according to the PBO).
Unlike in the U.S., Ottawa and the provinces don't backstop the private flood insurance market.
But there is a lot of confusion about who covers what. Governments are looking at growing liabilities. The insurance industry feels exposed, to growing risk to their finances and reputations.
And consumers are often oblivious about where their insurance coverage stops, and where disaster relief begins. Homeowners may unknowingly disqualify themselves from future disaster relief by not purchasing flood insurance, when it is available.
Pressure for reform is mounting. Alarmed at the escalating bill for weather-related disaster relief, Public Safety Minister Ralph Goodale is in talks with insurers and the provinces. A key meeting is slated for Nov. 16 in Regina.
The idea is to find a better way, in part by learning from what the U.S. and other countries are doing wrong. The objective is to create a regime that costs less, reduces moral hazard and sends all the right signals to consumers, developers and regulators.
The industry wants Ottawa to play a much larger role. Some industry insiders are pitching the idea that Ottawa and the provinces could put money into a flood insurance pool, collect premiums and even turn disasters into a profitable business for governments.
Others suggest the best way to go is a largely private system, backstopped by federal and provincial reinsurance to cover catastrophic events.
Getting it right will be a tall order.
Once drawn into the insurance game, Ottawa may feel intense pressure to expand its footprint and take on more risk, particularly as weather events become more frequent and virulent. Saying "no" to disaster victims is never easy.
The last thing Ottawa wants is to replicate the troubled U.S. federal flood insurance program, which has a $25-billion (U.S.) deficit that swells with every big storm.
Ottawa must tread carefully. It needs to limit its exposure, send the right signals to the market and above all, avoid the moral hazard trap.