At War with the Weather
The following post by Howard Kunreuther and Erwann Michel-Kerjan, authors of At War with the Weather, proposes an action plan to reduce future disaster losses in the wake of several catastrophic super storms and natural disasters.
The spate of disasters over the past year in the United States alone—the year—long drought, Hurricanes Isaac and Sandy in 2012, the severe Oklahoma tornadoes, and the flooding of the Mississippi this spring—illustrate the challenges we face in dealing with natural disasters. Hurricane Sandy caused an estimated $68 billion in economic losses to residences, business owners, and infrastructure. It is the second-most costly natural disaster in recent years in the United States, after Hurricane Katrina in 2005, but it is not an outlier. Economic and insured losses from devastating natural catastrophes in the United States and worldwide are climbing.
This trend will continue unless those in harm’s way take steps to reduce their risk. This is a challenge because of the human tendency to perceive the likelihood of a disaster as below our level of concern until after a disaster hits. In fact, it is often only after suffering a loss that homeowners purchase insurance voluntarily. Many then cancel their policy just a few years later if they have not made a claim. Our analysis of data from the National Flood Insurance Program, which provides coverage to 5.5 million policyholders today, highlights this point: about half of all new flood insurance policies are canceled only 3 to 4 years after they are purchased, even though many homeowners are required to have coverage as a condition for a federally insured mortgage.
The passage of the Biggert-Waters Act in July 2012, one of the most important pieces of disaster-related federal legislation in recent years, provides an opportunity to address this problem. The Act renewed the National Flood Insurance Program for five years and reformed it significantly, with plans for improved flood mapping to determine risk-based premiums, and a concern for issues of affordability -- two guiding principles for insurance from our recent book, At War with the Weather: Managing Risks in a New Era of Catastrophes.
Principle 1: Premiums Reflecting Risk. Insurance premiums should reflect risk so that it is transparent to residents how exposed they are with respect to damage from floods and other disasters covered by their policy. A risk-based premium also provides an economic incentive in the form of reduced premiums to property owners who invest in loss reduction measures.
Principle 2: Dealing with Equity and Affordability Issues. Higher premiums based on improved risk assessment are likely to impose a financial burden on low-income households. Insurance vouchers financed by general taxation may be the best way to make the risk-based rates equitable.
For the new flood insurance legislation to effectively reduce future flood losses and encourage investment in risk reduction measures, we urge the Federal Emergency Management Agency (FEMA) who implements the program to consider the following proposed action plan: create multi-year flood insurance policies combined with long-term mitigation loans. Both the insurance and loans would be tied to the property, not the individual, to avoid the tendency to cancel one’s insurance; the loan will spread the upfront cost of loss reduction measures (which is often a financial obstacle to the adoption of risk reduction) over the life of the house. Well-enforced building codes should complement the multi-year insurance program. Combined with a federal insurance voucher program to help those who currently live in hazard-prone areas and cannot afford risk-based insurance, this solution package would be both efficient and fair.
With the newly enacted Biggert-Waters Act and with the memory of Hurricane Sandy and Oklahoma City tornadoes still fresh in people’s minds, we have an opportunity to take important steps to reduce losses from future natural disasters. The time to act is now!