06/29/2010 10:58 am ET Updated May 25, 2011

Insuring the Flow of Oil

As a believer in well-regulated free enterprise, I am about to propose a free enterprise solution to guard against further deep drilling water catastrophes. I suggest that catastrophe lies within the province of the insurance industry, and I propose that the federal or state governments demand insurance coverage of all deep water drilling. It's now absolutely clear that deep water drilling is a risky business -- risk analysis is best left to insurance actuaries.

We now know that BP has put $20 billion into a reserve fund to cover the damages caused by the Gulf explosion. We also know that the administration has banned any more drilling for another five months, and that a judge says that the administration doesn't have a right to do so. The government is appealing; it may be months or even years before we get a final decision.

Meanwhile, the insurance idea works on two fronts. First, it permits deep drilling to go ahead reasonably quickly, and secondly, it gets an independent opinion of the real risk of deep water drilling. Insurance premiums are determined by actuaries, who, quoting Wikipedia, "mathematically evaluate the likelihood of events and quantify the contingent outcomes in order to minimize losses, both emotional and financial, associated with uncertain undesirable events." The Gulf spill is undoubtedly an "undesirable event," and now that it has occurred, it's time to insure against the next one.

The best evidence of risk is provided by people who put their money where their mouth is, and that's what insurance companies do. Their actuaries fix premiums to cover worst cases, while still providing profits to their companies' bottom line. BP has just provided insurance companies with a "worst case" example, and I expect that insurance actuaries could now come up with numbers that would "quantify the contingent outcomes in order to minimize losses." The insurance companies could then set premiums and the petroleum companies would have to pay them if they wanted to drill.

Of course, maybe the insurance companies would decide that deep water drilling was too dangerous to insure. If that were the case, it would tell us a lot about going forward. Or, the insurance companies might set the premium so high, that oil companies couldn't afford them. (I doubt that because oil companies seem to have unlimited power to raise prices). That, of course, would tell us something too.

So, before you "drill, baby, drill," governments, both state and federal, should demand "insure, baby, insure," and good luck to all of us. That's a free enterprise solution.