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The Role of Insurance in Reducing Losses from Extreme Events: The Need for Public–Private Partnerships

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Abstract

This paper describes the challenges that consumers, insurers and insurance regulators face in dealing with insurance for low-probability, high-consequence events. Given their limited experience with catastrophes, there is a tendency for all three parties often to engage in short-term intuitive thinking rather than long-term deliberative thinking when making these insurance-related decisions. Public–private partnerships can encourage investment in protective measures prior to a disaster, deal with affordability problems and provide coverage for catastrophic risks. Insurance premiums based on risk provide signals to residents and businesses as to the hazards they face and enable insurers to lower premiums for properties where steps have been taken to reduce risk. To address issues of equity and fairness, homeowners who cannot afford insurance could be given vouchers tied to loans for investing in loss reduction measures. The National Flood Insurance Program provides an opportunity to implement a public–private partnership that could eventually be extended to other extreme events.

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Notes

  1. Bainbridge (1952); Kunreuther and Roth, Sr (1998).

  2. Kahneman (2011).

  3. Cutler and Zeckhauser (2004); Krantz and Kunreuther (2007); Kunreuther et al. (2013c).

  4. Tversky and Kahneman (1973).

  5. Botzen et al. (2015).

  6. Michel-Kerjan et al. (2012).

  7. Palm (1995).

  8. Palm and Carroll (1998).

  9. Risk Management Solutions (2014).

  10. Grace et al. (2004).

  11. For more details on the interaction between regulators and insurers, see Grace and Klein (2007) and Kunreuther and Michel-Kerjan, (2011, chap. 3).

  12. For more details, see www.insurancejournal.com/news/southeast/2014/03/06/322378.htm.

  13. For more details on the history of flood insurance and recent developments, see Michel-Kerjan (2010), Michel-Kerjan and Kunreuther (2011) and Knowles and Kunreuther (2014).

  14. Overman (1957); Gerdes (1963); Anderson (1974).

  15. For information on earthquake insurance in the United States, see Roth, Jr (1998).

  16. California Department of Insurance (1997–1998).

  17. For more details on the history of terrorism insurance in the United States after 9/11, see Wharton Risk Center (2005) and Kunreuther et al. (2014).

  18. Cummins and Lewis (2003).

  19. Jaffee and Russell (2003).

  20. Michel-Kerjan (2003).

  21. Kunreuther et al. (1993).

  22. Cabantous et al. (2011).

  23. Lecomte and Gahagan (1998).

  24. These principles are discussed in more detail in Kunreuther and Michel-Kerjan (2011) and Kunreuther et al. (2013c).

  25. Grossi and Kunreuther (2005).

  26. Thaler and Sunstein (2008).

  27. See Johnson et al. (2012).

  28. Slovic et al. (1978).

  29. Weinstein et al. (1996).

  30. Slovic et al. (2000).

  31. Kunreuther et al. (2001).

  32. Madrian and Shea (2001); Thaler and Benartzi (2004).

  33. Kunreuther et al. (2013a).

  34. For more information, see shoreupct.org.

  35. For more details on these programmes, see Kunreuther and Michel-Kerjan (2011).

  36. National Research Council (2015).

  37. Kousky and Kunreuther (2014).

  38. For more details on the renewal of TRIA, see Kunreuther et al. (2014).

  39. Lewis and Murdock (1996).

  40. IBHS (2007).

  41. Insurance Institute for Property Loss Reduction (1995).

  42. Jaffee et al. (2010).

  43. Regulators would still monitor insurers to make sure that they have sufficient surplus on hand and are charging a sufficiently high premium to reduce the chance of insolvency to an acceptably low level.

  44. Kunreuther and Michel-Kerjan (forthcoming).

  45. This proposal for risk-based premiums and means-tested vouchers are part of BW12 that was modified in March 2014. The new legislation (HFIAA14) delayed the implementation of risk-based premiums until issues of affordability of the NFIP were addressed. The National Research Council is currently undertaking this study and issued its first report in March 2015 (National Research Council, 2015) where the methods for an affordability framework and programme policy options were proposed. The second report, due in the fall of 2015, examines the features of alternative approaches for undertaking a national evaluation of affordability programme policy options.

  46. U.S. Government Accountability Office (2008).

  47. Repetto and Easton (2012).

  48. See New York City Panel on Climate Change (2015), NYC (2013), and Hurricane Sandy Rebuilding Task Force (2013).

  49. Kunreuther et al. (2013b).

  50. Useem et al. (2015).

  51. See National Research Council (2012).

  52. See Michel-Kerjan and Pedell (2005) for a comparison of terrorism coverage in France, Germany and the United States. OECD (2012) presents a framework for assessing disaster risk and financial strategies for disaster risk management that serves as a reference point for comparing specific country approaches and methodologies.

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Acknowledgements

This paper reflects research and helpful discussions with my colleagues at the Wharton Risk Center and at other universities and research institutions, notably Jeffrey Czjakowski, Dwight Jaffee, Daniel Kahneman, David Krantz, Robert Meyer, Erwann Michel-Kerjan, Mark Pauly, Robert Shiller, Paul Slovic and Elke Weber. I also appreciate helpful interactions with members of the Wharton Risk Center’s Extreme Events project as to the challenges and opportunities faced by the insurance industry. Special thanks to the reviewers of the paper and to Carol Heller, Joan Lamm-Tennant and Erwann Michel-Kerjan for suggestions on an earlier draft of the paper. Funding for this research comes from the National Science Foundation (SES-1061882 and SES-1062039); the Center for Risk and Economic Analysis of Terrorism Events (CREATE) at the University of Southern California; the Center for Research on Environmental Decisions (CRED; NSF Cooperative Agreement SES-0345840 to Columbia University), the Zurich Insurance Foundation on community flood resilience and the Wharton Risk Management and Decision Processes Center.

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This paper has been granted the 2015 Shin Research Excellence Award—a partnership between The Geneva Association and the International Insurance Society—for its academic quality and relevance by decision of a panel of judges comprising both business and academic insurance specialists.

FM Global (2011).

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Kunreuther, H. The Role of Insurance in Reducing Losses from Extreme Events: The Need for Public–Private Partnerships. Geneva Pap Risk Insur Issues Pract 40, 741–762 (2015). https://doi.org/10.1057/gpp.2015.14

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  • DOI: https://doi.org/10.1057/gpp.2015.14

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