Adverse Selection In Action

I have a friend who is an actuary. He lives near a levee system in Southern California. He approached me and said, “I am thinking about buying flood insurance”. I thought that was odd. Most of California is in a drought, he’s owned his home for years and hasn’t had a whiff of flooding. He doesn’t live near a river bed or creek susceptible to flash flooding, so I was curious as to why he would want that specific coverage and why now?

He said that if the El Nino was as strong as the news outlets are letting up, then the water accumulations from the storms may cause creek levee to overflow its banks and go into his house.

I nodded in agreement. This was a good idea. This is the equivalent of buying hurricane insurance as the storm is about to make landfall. The price of the policy does not reflect the present risk of an increase in storm activity.

The purchase is likely to be a one-year bet. I don’t know what the likelihood of loss will be, but my actuary friend has laid some chips down because he senses he has the winning hand. Even if there are no flood claims, I think this is the smart move.

**********UPDATE 4-7-2016************************

Lots of rain but no flooding. Looks like the NFIP is going to make out well this El-Nino season!


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