risk-based pricing

The bright side of flood insurance

by Michelle Minton on January 22, 2010 · 1 comment

in Insurance

Some Michigan residents are boiling mad that their mortgage lenders are forcing them to purchase flood insurance. The notifications were sent out to residents as a result of FEMA’s adoption of updated flood maps. There is, however, good news here.

Consumers have options. FEMA is certainly not infallible.  The maps may not be accurate (I know it’s hard to believe) and homeowners can hire their own property surveyors to determine if they are in a floodplain and how likely it is that a flood will occur on their property. With these actions they may be able to avoid the mandatory purchase of flood insurance or at least they can reduce the cost by giving details about the risk of flood (as I wrote in an earlier blog post insurers can charge less when they are more certain of the risks). Additionally, the more residents who assess the risks associated with their property provide more thorough details for their insurance companies which means that these companies can come closer to risk-based-rates for all of their customers and potentially charge less for everyone as the result of higher profits.

In addition, some consumers who have their property surveyed might find out that they are not in a flood zone though they thought they were and had already purchased flood insurance–in which case they can have their premiums refunded from the previous and current year.

On the flip side, some residents who have their properties surveyed might just find out that they are indeed in a flood plain and they may have to purchase flood insurance. But how “bad” is it really when people are forced to calculate and prepare for a hazard that is very likely to occur?

Obama credit card meeting — should meet with economists instead

by John Berlau on April 23, 2009

in Bailout Watch, Deregulate to Stimulate, Mobility, Nanny State, Politics as Usual, Precaution & Risk, Zeitgeist

Instead of meeting with the executives of credit card issuers and sactimoniously lecturing them about not raising rates, as he is doing today,  President Obama would serve card holders more effectively by meeting with economists and listening to their concerns about the dangers of price controls on credit card services. Economists from all schools of thought — from Keynesian to supply-side — recognize the basic principle of microeconomics that price controls lead to shortages of  commodities, including credit, and cause distortions that harm ordinary consumers.

Limits on risk-based pricing, as enacted in rules last year from the Federal Reserve, and in proposals in Congress that go beyond these rules, could result in sharp limits in the availability of credit at  a time when policy makers want to get credit flowing again. Recent cuts in consumers’ lines of credit over the past few months are in part responses to thes Fed rules that ban sensible risk-based pricing practices, such as the so-called “universal default.” Under this longstanding practice, credit card issuers would sometimes raise rates for defaults on another credit card or loan, because this may have signaled a weakeniong in a consumer’s credit profile. Now with the looming ban of this practice, credit card issuers may be reacting by limiting credit lines for all card holders because of the loss of the ability to engage in this type of risk-based pricing. So responsible card holders who never miss a payment are paying the price for these misguided rules.

And consumers and the economy will pay an even higher price if further restrictions are enacted such as proposed caps on annual percentage rates. Politicians don’t seem to grasp that expanding credit responsibly is incompatible with limiting risk-based pricing. Again, responsible card holders — some of whom don’t even pay interest because they completely pay off their balances — could lose out in the form of the return of annual fees and the loss of credit card “rewards” such as airline miles to make up for the costs from bans on risk-based pricing.

President Obama may also want to read studies sponsored by the respected Kauffman Foundation in Kansas City, Mo., that find that personal credit cards are a major source of funding for startup entrepreneurs. Most famously, Sergey Brin used personal credit cards as a college student in the 1990s to start the web search engines that is today know as Google.

In some instances, credit cards have been issued foolishly by banks and used foolishly by consumers. Fraud in credit card practices should be punished just as fraud is in any type of business. But there should not be a “Nanny State” standing between willing lenders and willing consumers who desire to lend and borrow at agreed-upon rates. Otherwise, the enterprises of the future Sergey Brins may be snuffed out from the lack of innovation in credit.