Economies of Scale in the Hurricane Industry?

A strange thought came to mind while reading through the news and pondering economic principles. I realized that the circumstances of late have given us a peculiar opportunity- three hurricanes in a matter of a month or so and landing in roughly the same area of the country. This lead me to wonder about the costs that insurance companies will bear after Ivan hits. Will the costs follow the economic laws dealing with economies of scale and marginal costs?

Given, that to measure this accurately it would probably need to be assumed that each hurricane was identical in size, damage, etc. and that they hit the same exact spots on the map. However, suppose that we set up a model involving cost and number of hurricanes. The cost would be on the vertical axis and the quantity of hurricanes on the horizontal. Would incurance companies experience economies of scale as the number of hurricanes increased? Though insurance companies are paying out millions of dollars, could they reach a point where they actually make a profit?

TheStreet.Com analysts say that it is not uncommon for stocks to fall shortly before a hurricane and rise shortly after due to the perception that insurance companies will raise premium rates. It will yet be determined if insurance companies will raise premiums, but for reason of experimental thought, we can assume they will. Could it happen where, if enough hurricanes happened, that the marginal cost of hurricanes will equal the marginal "gain" that companies experience from the rise in stocks and premium hikes?

Suppose someone were crazy enough to invent a hurricane machine that could create hurricanes on demand. This person would probably be tied to an insurance company and have some sort of possibility of capital gain, not to mention a lack of morals evident by their willingness to kill strangers. However, suppose the machine was made and the person or a group of people strategically planned a series of hurricanes in order to make a profit, unbeknownst to innoccent policy holders. Granted that these individuals would not be acting rationally, but then again, Adam Smith didn't even believe that we can count on everyone acting rationally all of the time.

What do you think? Are there other factors that need to be considered that either make this possible or throw the idea right out the window?

1 comment:

Dr. Tufte said...

One misspelling.

I would think that insurance firms probably do experience economies of scale from multiple disasters. They have to have a lot of unused capacity available to deal with the potential for emergencies.

I'm not aware of any disaster pattern in stock prices (but I discount it when the financial media says that some event caused prices to move some way - I think they just make most of it up as they go along).

As to causing hurricanes for fun and profit, this is what Basquiat (the 19th century French economist, not the 20th century Haitian grafitti artist) referred to as the "broken window" paradox. When a vandal breaks a window, it creates work for a lot of people - but it still isn't good for society.