Thursday, August 11, 2011

Contingent Failures

Not much notice of some coverage of the now-failed sewer line 'insurance' programin the city of Pittsburgh.  See WPXI:  PWSA Insurance Fails Customers; Legal Action Taken. Seems to me someone might want to go in and audit the rump company to figure how big this potential problem is with clients being hit with bills and legal actions derivative from the insurance company's collapse.  I don't think they had just one contractor doing the work out there did they?

Here is the fundamental issue that nobody really talked about from early on and long before we got to this point.  There is a reason that insurance markets are some of the most regulated markets everywhere and always.  It is far too easy to set up an insurance program, take in premia for a long time, and along the way not put aside enough in cash or assets to cover the future contingencies supposedly being insured against.  Some future bankruptcy devolves the 'insurance' into a ponzi scheme.  Regulation comes into play to make sure there is some semblence of assets held in reserve to the potential future claims.

So was the PWSA sponsored program ever really 'insurance'?  Legally probably not.  As pointed out quite accurately by a commenter here (MH?, I forget) the PWSA program was actually a 'warranty' program.  The legal distinctions between insurance and warranty are not as great as the semantic ones.  It can be a fine line between a warranty and an insurance contract.  The distinction means less in economics than it does in the law where the difference is palpable with regards to regulation in most states.  So I am not saying anything was illegal and most sewer line 'insurance' programs are really warranties in their contract verbiage.  Economically they really appear to me to be insurance nonetheless.. let alone in the popular vernacular.

So go back to the WPXI story today.   Does it really matter that the PWSA program was shut down?  Short term or long term, if there was a correctly calculated amount of cash being put away for the contingencies being insured against then there should be no unmet contingent claims.  The fact that there seems to not be sufficient assets for the few claims already taken in by the program only raise bigger questions about whether there would have been sufficient assets over the longer run. 

This all gets to the most difficult question for insurance markets whether regulated or not.. how much to be saved and what price to charge?  Contingent claims markets of all kinds are some of the hardest to ever determine an efficient price in a free market.  The problem is that so much depends on the unknown parameters of the future.  That is true of all insurance markets, but for some that unknown future has been studied to death.. quite literally.  Most all of actuarial science is dedicated to the mortality quantification that is the heart of life insurance.  So I bet they come pretty close to getting the numbers right. 

Thus the number one question is whether such actuarial accuracy could ever be replicated in predicting the future of the city of Pittsburgh aging and ageless water infrastructure.  The PWSA cant even identify all the leaks it has in its backbone now and I bet there just isn't any meaningful estimate of what it would cost to replace the whole system.  What they know about the condition of individual taps to each and every home in the city is likely an order of magnitude even smaller.   So it seems obvious to me that worse than most any othe water system in the nation (because of it's age and relative lack of investment for so long) nobody can really know what a fair price would be for a sewer line insuranace program.  

At the core then is why a new company jumped into the breach and try and fill this apparent lack of market for a decently priced insurance program, whether sold individually to homeowners or collectively via the PWSA.  There appeared to be a big profit and some entrepreneurial sorts jumped in to fill the gap with winners all around.  Sort of the way the free market should work.  But it was likely an illusion.  The mispricing of the future risk is all that was really going on here and eventually.... down the road it may have been.. it really was impossible to collectively insure the failure of Pittsburgh's aging water infrastructure at a price that anyone would accept. I won't get into the pseudo-profit built into this particulal scheme which was the offer of the insurance program to pay for some rehabilitation of the PWSA's public drains at the same time... there certainly was not money for that and may be a core reasons some homeowners are being left adrift because of lack of assets.  That could in some parlances be called a 'side payment'.

and don't get me going on the economic failings, and impossibilities, of the defunct WEHAV insurance once thought up for Pittsburgh's West End neighborhoods.  Insurance can fill great gaps in the market by reducing risk when desired, but it can't solve all problems.

PS.  Brings up a real question for the future of the system.  Have they made any progress finding anyone to actually run the PWSA?


Anonymous MH said...

The insurance/warranty distinction sounds more nuanced than is usual for me. Maybe Brian?

Thursday, August 11, 2011 2:31:00 PM  
Anonymous The Wiz said...

Sounds like more hard earned money going down the sewer.

Sorry, couldn't resist

Friday, August 12, 2011 10:00:00 AM  
Blogger SteelCityMud said...

I was sorry to see so little in the way of comments on this post as I think mismanagement at PWSA is a shining example of the style of politics that too often dominates this city.

I can't help but notice that the failure to pay out claims directly contradicts a statement made by PWSA back in March.

""Any warranty line repairs now in progress will be completed. Any claims appropriately submitted before March 18, 2011, at 12:00 p.m. will be addressed as required by the ULS Line Warranty Program Terms and Conditions. As of March 18, 2011, at 12:00 p.m., no new claims on the ULS Line Warranty Program are being accepted, and the $5 monthly charge to participating PWSA customers has ceased."

Now a failure to put away money is clearly blameworthy but what makes this program so egregious is that it seemed to be flush with cash. Indeed, Michael Lamb thought the program was so lucrative that PWSA should take it over rather than contract it out.

If they can't afford to pay claims now, it seems that this is pretty solid evidence that ULS must have mismanaged its funds to a criminal degree - or, I suppose they might have just stolen those funds. Not that there is really a difference either way.

Do you know of any plans taking place now in PWSA to ensure that it can make good on its statement back in March? Is there any way for ordinary home-owners to pursue PWSA directly since they are the ones that put a contract in place between customer, ULS and the unpaid plumbers?

Tuesday, August 16, 2011 2:41:00 PM  

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