by Michael Igo, Affiliate ASLA, PE, D.WRE, LEED AP, CID
Whether it’s a fender-bender, a prescription co-pay, or a tree branch falling on our house, insurance is a part of our daily life and economy. The insurance business has been around for millennia. As landscape professionals, we often equate irrigation with an insurance policy against drought. But, when we actually apply the basic principles of insurance to irrigation, we see that the current system of water allocation for landscapes is faulty.
Consider a landscape owner deciding to install an irrigation system: they desire an “insurance policy” to avoid the risk of plant death during drought. The money paid to an installer could be considered the “insurance premium” to deliver water to the landscape. However, if we take a closer look, the real insurer is not the irrigation installer—it is Mother Nature paying out in freshwater supplies!
In the diagram below, we have a situation where the landscape irrigation owner, “the policyholder,” is paying a “premium” in the form of money, but the insurance company, Mother Nature, is not receiving these premiums and is constantly paying out in the form of water. In this case, the policyholder’s actual cost to the insurer is zero. This underscores the reality that most land developers do not pay the environmental cost necessary for Mother Nature to sustain her resources for all.
Insurance is a sustainable business model because it generally provides a “win-win.” The customer gets peace of mind by avoiding risk and the insurance company generally turns a profit on premiums collected by assuming a series of prudent risks over many policies. If this business model can be applied to irrigation and water resources, it may be possible to achieve a true symbiosis between irrigation water consumers and Mother Earth. Precious water resources can be sustained by following this business model.
Typical insurance policies are drafted with limits on coverage, deductibles (meaning the policyholder pays first before any insurance payout), and co-pays (both insurer and insured pay). Moreover, there are very strict rules with policies that, if broken, can render them null and void. Thus, insurance, generally, is provided incompletely. However, with irrigation systems, they provide full insurance against drought—an untenable insurance business practice. People may prefer full insurance, but as David Autor, the Ford Professor of Economics at MIT, explains, there are four general reasons why full insurance is not offered by successful insurance corporations (Professor David Autor, 2004 Massachusetts Institute of Technology Course 14.03: Microeconomics and Public Policy):
1. Credit Constraint: Full Insurance Policies Would Cost Too Much
Even if offered, the premium for full insurance would be too high and people simply could not afford it because the insurance company has to make a profit. The reality with irrigation as highlighted in the diagram above is that there is no cost or “premium” paid to Mother Nature and her freshwater supplies for the privilege of full insurance. If Mother Nature were an actual insurance company, she would go bankrupt very quickly. For her to stay viable as a source of emergency water, there needs to be a credit constraint on the resources offered for either full or incomplete insurance from drought.
2. Non-Diversifiable Risk Cannot Be Insured
Widespread catastrophes cannot be insured because the entire pool of insured persons would be affected and expecting payout. Drought is a non-diversifiable risk for a region. If an area has no freshwater, then all are subject to that catastrophe. Mother Nature cannot pay out in water if there is none to give. Insurance companies must pay their policyholders with monetary funds held in reserve for when particular events occur. In this case, Mother Nature must pay out for all events with her reserves from aquifers, lakes, and rivers. If 1,000 businesses and residences have similar landscapes, all with traditional water-wasting landscape irrigation during a drought, then the “insurance payout” in the form of freshwater would be astronomical. The reserve water sources will run dry quickly. Legally and ethically, no insurance company would assume the risk of an event occurring if they could not pay out when it occurred. Car accidents are an example of diversifiable risk in that not everyone is going to damage their car at the same time. However, everyone in a region will feel the effects of drought simultaneously, thereby making it a non-diversifiable risk.
3. Adverse Selection of Policy Candidates for Insurance Companies
Underwriting is a necessary process for insurance of evaluating risks and then accepting, modifying, or rejecting coverage based on a wide variety of information available from the potential policyholder and actuarial analysis (Robert Mehr and Emerson Cammack, Principles of Insurance (1976), R.D. Irwin, Homewood, Illinois). Without underwriting, the pool of profitable candidates to offer policies to becomes extremely hard to discern or non-existent. For example, with no life insurance underwriting, people would not opt for a policy while they were young and then buy a policy only in their most advanced years or upon knowledge of a terminal disease. With irrigation, while environmental agencies do their best to restrict tapping into natural water resources, there are generally fewer restrictions to tap into municipal domestic systems that could be used for more important uses such as drinking, bathing, cooking, and sanitation. When an insurer accepts all applicants for full insurance without underwriting, the selection process to find profitable policies to offer becomes adverse. Since all life insurance applicants are on the verge of dying, there is no opportunity for the insurance companies to profit from premiums. If all seekers of irrigation system installations are allowed to freely tap into Mother Nature’s freshwater reserves without underwriting or regulations, then an adverse selection on responsible water users exists.
4. Moral Hazard
Once a person is insured, there is a moral hazard to take more chances and engage in riskier behavior. This makes policies riskier and profit-prohibitive for the insurance company. Once an irrigation system is installed, the tendency is to not maintain it, not fix it, and allow water to be dispensed haphazardly. In a real insurance policy, it is up to the policyholder to uphold their part of the bargain in maintaining the insured asset, such as your home, car, health, and life. Insurance inspectors will often make visits to properties and assets to ensure infrastructure is safe and maintained as a condition of the policy. Often, water-conserving irrigation is up to the landscape owner alone. Irrigation controllers that automatically monitor climate and adjust or suspend watering automatically can help manage water wisely. Automatic flow and weather sensors are effective in curbing water waste, but, once an irrigation system is installed, the moral hazard still exists for the “insured” landscape owner to allow waste through mismanagement and general disregard.
Below are some suggested irrigation and water resource management ideas that use the same principals as sustainable insurance companies:
- Recognize that watersheds and aquifers are not unlimited supplies and that a reserve must be held to payout water in actual emergencies for drinking, bathing, cooking, and sanitation. Drought and climate change are non-diversifiable risks that cannot be fully insured.
- Provide a credit constraint for seekers of freshwater for irrigation. Only allow access to water for landscape irrigation systems by making owners pay for climate-based and flow-sensing water saving features as a condition of the insurance policy. Enforce higher water rates for irrigation versus other more important water uses.
- Do not allow full insurance by instituting and enforcing water bans, caps on coverage, and overall water use. The seasonal variability of climate mirrors the variability of financial markets. Use the same principles to forecast trends for large payouts and be proactive.
- Require landscape owners to provide a “deductible” in the form harvested rainwater or greywater. Require the policyholder to “pay in water” first by using their own self-generated sources before Mother Nature pays out in freshwater. The Living Building Challenge (LBC) is an example of a system that requires net positive water back to the Earth for development projects.
- Stricter underwriting by local, state, and federal water permit with conditions to prevent adverse selection. Understand who the water user is, what assurances they will provide to preserve water, and report a loss through actual metering and flow sensing data.
- Provide strict inspection and commissioning of irrigation systems by local authorities to prevent a moral hazard of irrigation disrepair and water waste. Internet-based irrigation systems allow for the transmission of data to water authorities, reducing the need for on-site inspections.
Insurance is a complex financial instrument; this article provides the briefest of explanations. Insurance companies that did not foresee the widespread, nearly non-diversifiable, mortgage-backed securities default crisis in 2008 were deemed “too big to fail” and some were bailed out by the federal government. No one has the ability to bail out Mother Nature as the “Ultimate Insurer” unless we take action now. If we recognize that irrigation is a necessary measure to “insure” that landscapes stay beautiful and useful, we need to take responsibility and apply the same financial principles.
Michael Igo, Affiliate ASLA, PE, D.WRE, LEED AP, CID, is President of Aqueous Consultants, LLC Of Andover, Massachusetts. Mike is a Professional Engineer with over 20 years of experience, licensed in 12 states, designing and managing water resources projects. As a self-proclaimed “right-brained engineer,” his dual love of science and graphics resonates with architects. Mike fulfilled his lifelong dream by founding Aqueous Consultants in 2014. His unique education with a B.S. in Aerospace Engineering and M.S. in Civil Engineering lends to design of both mechanical (irrigation, pumps, controls) and civil systems (ponds, tanks, drainage). He has documented over 100 Water Efficiency credits for LEED and programmed Aqueous’ computer climate model. Mike has spoken at many national and regional ASLA events, and currently serves as co-chair for ASLA’s Water Conservation Professional Practice Network (PPN).