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Managing Catastrophic Risks Through Redesigned Insurance: Challenges and Opportunities

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Handbook of Insurance

Abstract

Catastrophic risks associated with natural disasters have been increasing in many countries including the United States because more individuals and firms have located in harm’s way while not taking appropriate protective measures. This chapter addresses ways to reduce future losses by first focusing on behavioral biases that lead homeowners and decision-makers not to invest in adequate protection. It then turns to developing proposals for risk management strategies that involve private–public partnerships. These include multiyear insurance contracts with risk-based premiums coupled with mitigation loans and insurance vouchers to address affordability concerns for low-income homeowners, tax incentives, well-enforced building codes and land-use regulations.

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Notes

  1. 1.

    Catastrophes are classed as “great” if the ability of the region to help itself is overtaxed, making inter-regional or international assistance necessary. This is normally the case when thousands of people are killed, hundreds of thousands made homeless or when a country suffers substantial economic losses.

  2. 2.

    On the question of protection of critical infrastructures, see Auerswald et al. (2006).

  3. 3.

    Reeves (2004, 2005) shows that a battleground state with 20 electoral votes received more than twice as many Presidential disaster declarations as a state with only three electoral votes.

  4. 4.

    See Cummins, Suher, and Zanjani (2010) for a more systematic analysis of government exposure to extreme events.

  5. 5.

    Moss (2002; 2010) and Eisensee and Stromberg (2007) have shown the critical role played by increasing media coverage of disasters in increasing government relief in the United States. See Kunreuther and Miller (1985) for a discussion on the evolution of disaster relief in the 1980s. See also Raschky and Schwindt (2009) and Jaffee and Russell (2012).

  6. 6.

    It is surprising how little data are publicly available on how much victims of disaster actually receive as direct aid. The Federal Emergency Management Agency (FEMA) has a series of disaster relief programs, but most of them are loan based (e.g. Small Business Administration’s program). This can address the liquidity issues that victims and their families face after a disaster, but does not transfer the loss to a third party, as insurance does.

  7. 7.

    See Browne and Hoyt (2000) for a discussion of the notion of “charity hazard.”

  8. 8.

    There are other insurance programs in which the liability of the federal government is very significant as well, such as flood insurance, crop insurance, and terrorism risk. See Brown (2010) for a review.

  9. 9.

    The analysis was undertaken by Mark Pauly.

  10. 10.

    For our Florida analysis, we assumed that the homes met the standards of the “Fortified…for Safer Living” program. Information on this program is available on the website of the Institute for Business and Home Safety at www.disastersafety.org as of June 2012. The benefit analysis was undertaken by the authors in partnership with Risk Management Solutions (RMS). For more detail about the methodology, see Kunreuther and Michel-Kerjan (2011).

  11. 11.

    Insurers are typically more proactive at working with their commercial clients to reduce their exposure. Those prices are not regulated and the premium for each contract is typically fairly substantial, providing an incentive for the insurers to inspect each commercial building it covers (Auerswald et al. 2006)

  12. 12.

    This section is based on Kunreuther, Meyer, and Michel-Kerjan (2013).

  13. 13.

    A discussion of alternative flood reduction measures can be found in Laska (1991) and Federal Emergency Management Agency FEMA (1998).

  14. 14.

    Tax incentive programs such as this one should encourage homeowners to take out a larger deductible on their insurance policy and contribute more to the Catastrophe Savings Account. In the process they pay lower insurance premiums and lower taxes at the same time. The insurer benefits by having lower claims following a disaster. If many homeowners take advantage of this program by raising their deductible, the insurer’s catastrophic exposure could be significantly reduced.

  15. 15.

    More recent building codes were established in 2004, then in 2007. See www.FloridaBuilding.org.

  16. 16.

    This proposal for risk-based premiums and means-tested vouchers are part of the Biggest-Waters Flood Insurance Reform Act that reauthorized the NFIP for five years in July 2012.

  17. 17.

    This subsection is based on Kunreuther (2005).

  18. 18.

    This document was proposed by the OECD Secretary-General Board on Financial Management of Catastrophes that has been advising the head of the organization and the governments of member countries since its inception in 2006.

  19. 19.

    More details on this program can be found at http://www.frac.org/html/federal_food%7B_%7Dprograms/programs/fsp.html.

  20. 20.

    For instance, at the end of August 2007, Secretary of Health and Human Services (HHS) Mike Leavitt announced that $50 million in emergency energy assistance would be given to 12 states that experienced much hotter than normal conditions during the summer.

  21. 21.

    For more details on this program, see U.S. Department of Health and Human Services at http://www.acf.hhs.gov/programs/liheap/

  22. 22.

    For more details on this program see http://www.usac.org/about/universal-service as of October 2011.

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Authors and Affiliations

  1. Center for Risk Management and Decision Processes, The Wharton School, University of Pennsylvania, Philadelphia, PA, 19104, USA

    Howard Kunreuther & Erwann Michel-Kerjan

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  1. Howard Kunreuther
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  2. Erwann Michel-Kerjan
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Correspondence to Howard Kunreuther .

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  1. Finance, HEC Montreal, Montreal, Québec, Canada

    Georges Dionne

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Kunreuther, H., Michel-Kerjan, E. (2013). Managing Catastrophic Risks Through Redesigned Insurance: Challenges and Opportunities. In: Dionne, G. (eds) Handbook of Insurance. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0155-1_19

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