Senator Wicker Roundtable

8/9/2019 Senator Wicker Roundtable

1/34

Long Term Strategies for Reducing

Losses from Hurricanes and Floods:

Howard Kunreuther and Erwann Michel-Kerjan

[email protected] -- [email protected]

Risk Management and Decision Processes CenterThe Wharton School, University of Pennsylvania

Senator Roger Wickers Roundtable

Gulfport, MississippiApril 8, 2010

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

$ 0 $ 10 $ 20 $ 30 $ 40 $ 50 $6 0 $7 0 $ 80 $ 90 $ 10 0

Loss(in $Billions)

ExceedanceProbability

Gross Loss
mailto:[email protected]:[email protected]://images.google.com/imgres?imgurl=http://nctequality.org/images/spring%20capitol%202.jpg&imgrefurl=http://nctequality.org/visit_legislators.asp&h=2048&w=1536&sz=516&hl=en&start=36&tbnid=O_bEORZc5vUMZM:&tbnh=150&tbnw=113&prev=/images?q=capitol+us&start=20&ndsp=20&svnum=10&hl=en&hs=G66&lr=&rls=DGUS,DGUS:2006-15,DGUS:en&sa=Nhttp://www.iii.org/media/facts/statsbyissue/tornadoes/mailto:[email protected]:[email protected]


2/34

Outline of Talk

1. A New Era of Catastrophes

2. Why Flood Insurance Matters: A Word on the NFIP

3. Guiding Principles for Insurance

4. Importance of Adaptation/Mitigation

5. A New Proposal: Long-Term Flood Insurance (LTFI)

6. Encouraging Mitigation through LTFI: An Example7. Summary

2


3/34

Worldwide Evolution of Catastrophe Insured Losses, 1970-2008

(Property and business interruption (BI); in U.S.$ billon indexed to 2007, except 2008 which is current)Sources: Kunreuther and Michel-Kerjan,At War with the Weather(2009) - data from Swiss Re and Insurance Information Institute

0

5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

80

85

90

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Man-made catastrophes Natural catastrophes

9/11/2001 loss (property and BI) 9/11/2001 loss (liability and life)

3


4/34

4

Event

Victims (Dead or missing) Year Area of Primary Damage$ Billion paid byprivate insurance

$ Billion paid bythe U.S. NFIP

Hurricane Katrina 1,836 2005 USA, Gulf of Mexico, et al. 47.9 17.5

9/11 Attacks 3,025 2001 USA 36.7

Hurricane Andrew 43 1992 USA, Bahamas 24.5 0.3

Northridge Earthquake 61 1994 USA 20.3

Hurricane Ike 348 2008 USA, Caribbean, et al. 15.9 2.6

Hurricane Ivan 124 2004 USA, Caribbean, et al. 14.6 1.8

Hurricane Wilma 35 2005 USA, Gulf of Mexico, et al. 13.7 0.4

Hurricane Rita 34 2005 USA, Gulf of Mexico, et al. 11.1 0.6

Hurricane Charley 24 2004 USA, Caribbean, et al. 9.1 0.06

Typhoon Mireille 51 1991 Japan 8.9

Hurricane Hugo 71 1989 Puerto Rico, USA, et al. 7.9

Winterstorm Daria 95 1990 France, UK, et al. 7.7

Winterstorm Lothar 110 1999 France, Switzerland, et al. 7.4

Winterstorm Kyrill 54 2007 Germany, UK, NL, France 6.3

Storms and floods 22 1987 France, UK, et al. 5.9

Hurricane Frances 38 2004 USA, Bahamas 5.8 0.2

Winterstorm Vivian 64 1990 Western/Central Europe 5.2Typhoon Bart 26 1999 Japan 5.2

Hurricane Gustav 2008 USA, Caribbean, et al. 5.2 0.1

Hurricane Georges 600 1998 USA, Caribbean 4.6 0.3

Tropical Storm Alison 41 2001 USA 4.3

Hurricane Jeanne 3,034 2004 USA, Caribbean, et al. 4.3 0.2

Typhoon Songda 45 2004 Japan, South Korea 4.0

Thunderstorms 45 2003 USA3.6

Hurricane Floyd 70 1999 USA, Bahamas, Columbia 3.5 0.6

The 25 Most Costly Catastrophe Insurance Losses, 1970-2008(17 here in the U.S., 12 of these since 2001; 23 are climate-related; in 2009 prices)

*

*

*

*

*

*

*

*

*

*

*

*


5/34

5

0

10

20

30

40

50

60

70

80

Total number of declarations

42

34

75 7568

45

Disasters in the U.S. - Presidential Declarations per Year

(with some election years highlighted in black)


6/34

6

0

10

20

30

40

50

60

70

80

Total number of declarations Declarations associated with floods

Floods Account for the Majority of the

Presidential Declarations


7/34

7

Two emergency supplemental appropriations bills(P.L. 109-61and P.L. 109-62) were enacted by Congress that provided $62.3billion for emergency response and recovery needs.

In 2006, another $19.3 billion was appropriated in supplementallegislation (P.L. 109-234) for recovery assistance (in 2006 dollars).

Taken together, this $81.6 billion federal relief is more than the

total insurance claims paid by private insurers for damage due towind, and payments by the NFIP for flood damage caused byHurricane Katrina, combined.

Federal Relief in Response to Hurricane Katrina in 2005


8/34

8

Whats Happening? The Question of Attribution

Higher degree of urbanization

Huge increase in the value at risk- E.g.: population of Florida

2.8 million inhabitants in 1950 - 6.8 million in 1970 - 13 million in 199019.3 million population in 2010 (590% increase since 1950)

-A direct hit on Miami by Hurricane Andrew in 1992 would have cost $60bn, and would havecost $120bn in 2004, because the exposure has doubled (ISO) - and is still increasing

Weather patterns-Among the top 25 most costly insured natural disasters that occurred in the past 40 years,23 wereweather-related events- Changes in climate conditions or return to a high hurricane cycle? Or a combination ofboth?

Direct consequence:

More intense weather-related events which cost more, much more.

Will the 2010-2015 period be even worse?


9/34

9

Insured Exposure on the Coasts

(Texas to Maine as of Dec. 2007):

$10 trillion

US Exposure to Natural Catastrophes


10/34

Key Features of the NFIP

Created in 1968 in response to belief that flood peril wasuninsurable.

The majority of NFIP policies are written through the Write-Your-Own (WYO) Program

The insurance companies bear no risk and are compensated forwriting policies and settling claims (30 to 40% of collectedpremiums)

Annual insurance contract menu and pricing set by the NFIP.

The program is waiting to be renewed and reformed

10


11/34

Total Policy-in-Force by Year

(in million policies; 1978-Dec. 2007)

Total premiums collected by year ($billion)

NFIP Total coverage-in-force (in $ billion)

Today: 5.58 million policies in place

Today: Over $1.2 trillion in coverage

About $2.8 billion in premiums

11


12/34

12

Financial Balance of the NFIP

Sources: Michel-Kerjan (forthcoming)


13/34

Was Katrina An Outlier or A Predictor of

The Future?

The historical number of claims stemming from the2005 hurricanes forced the program to borrow$17 billion from the U.S. Treasury.

By its own admission, it is unlikely the NFIP willbe able to ever repay this debt.

This demonstrates that the NFIP is not designed,as it currently operates, to be self-sufficientfinancially in the aftermath of large-scale disasters.

13


14/34

Outline of Talk






6. Encouraging Mitigation through LTFI: An Example7. Summary

14


15/34


Insurance premiums should be based on risk in order to provide signalsto individuals as to the hazards they face and to encourage them toengage in cost-effective mitigation measures to reduce their vulnerability

to catastrophes. Risk-based premiums should also reflect the cost ofcapital insurers need to integrate into their pricing to assure adequatereturn to their investors.

Any special treatment given to homeowners currently residing in hazard-prone areas (e.g., low-income uninsured or inadequately insuredhomeowners) should come from general public funding and not throughinsurance premium subsidies.

15


16/34

Insurance Vouchers

Existing Programs as Models

Food Stamp ProgramMission:Vouchers to purchase food based on annualincome and family size

Low Income Home Energy Assistance Program

Mission:Assist low-income households in meetingimmediate energy needs

Universal Service Fund

Mission:Provide discounts to low-income individuals inrural areas so rates for telecommunications services are

comparable to urban areas 1616


17/34

Insurance Vouchers

Who Should Subsidize Low-Income Residents?

General taxpayer Everyone in society is responsible

State government Source of funding would come

from state taxes

Insurance policyholders All homeowners withinsurance

Residents in coastal areas Those in hurricane-prone areas

1717


18/34


Individuals do not adopt loss reductionmeasures for various reasons

These measures can reduce losses significantly

Long-term insurance coupled with long-term

loans can induce people to invest in cost-

effective loss reduction measures

18


19/34

The National Flood Insurance Program (NFIP) does not cover winddamage from hurricanes but major hurricanes in coastal statestypically also induce significant storm surge pushing water inland

In 2004 86% of the NFIP claims in Florida were attributable toHurricanes Charlie, Frances, Ivan and Jeanne

Relationship between Hurricanes

and Flood-Related Damage

B fi f Mi i i


20/34

Effects of Mitigation on a 500 Year Event

0

20

40

60

80

100

120

140

160

180

FL NY SC TXState

Losses(Billion

s)

Savings from Mitigation

Remaining Losses

$160 billion loss

$82 billion saving with

mitigation in place

Benefits of MitigationOn a 500-Year Event

20


21/34

Why dont many people in catastrophe-prone areasinvest in risk reduction measures?

Wharton Risk Center Issues Paper #1

Short Time Horizons (Quick return on investment)

High Short-Term Discount Rates (Hyperbolic discounting)

Misestimating Probability (Flood will not happen to me)

Liquidity and Upfront Costs (We live from payday to payday)

Truncated Loss Distribution (Only responsible for small portion of

loss due to disaster relief)

May Move in 2 or 3 Years (Cant recover costs of adaptation)2121

T


22/34

Proposed Strategy: A New VisionLong-term flood insurance contracts through National

Flood Insurance Program (NFIP) (5-, 10, 20-years

insurance coverage)

Long-term home improvement loans for mitigating

ones property

Insurance and loans are tied to the property, not tothe individual

5. A New Proposal: Long-Term Flood Insurance(LTFI)

22
http://www.photos.com/en/search/close-up?eqvc=92598&oid=3662084&a=&pt=&k_mode=all&k_exc=body&cid=&date=&ct_search=&k_var=mortgage&bl=%2Fen%2Fsearch%2Findex%3Ff_h%3D1%26f_i%3D1%26f_o%3D1%26f_v%3D1%26f_b%3D1%26f_c%3D1%26k_exc%3Dbody%26k_var%3Dmortgage%26k_mode%3Dall%26big%3D1%26srch%3DSearching...%26&ofirst=&srch=Y&hoid=9e340d2b4c8369ba8867ac9400dc2ac1http://www.photos.com/en/search/close-up?eqvc=92598&oid=3662084&a=&pt=&k_mode=all&k_exc=body&cid=&date=&ct_search=&k_var=mortgage&bl=%2Fen%2Fsearch%2Findex%3Ff_h%3D1%26f_i%3D1%26f_o%3D1%26f_v%3D1%26f_b%3D1%26f_c%3D1%26k_exc%3Dbody%26k_var%3Dmortgage%26k_mode%3Dall%26big%3D1%26srch%3DSearching...%26&ofirst=&srch=Y&hoid=9e340d2b4c8369ba8867ac9400dc2ac1


23/34

LTFI Provides Stability to Homeowners

Rates would reflect risk (Principle 1)(FEMA needs to design better maps)

Insurance Vouchers for those needing special treatment

(Principle 2)(Only for those currently residing in flood-prone areas)

Homeowners would have knowledge that they are

protected against water damage from floods andhurricanes

23


24/34

LTFI Provides Stability to NFIP

It would sustain revenue for the program over time by

having a much larger policy base.

If homeowner moved to another location, the flood policy

would remain with the property unless the new owner

did not have a federally insured mortgage.

Consider requiring everyone in flood prone areas to have

flood insurance. Would assure spread of risk within the

NFIP program.

24


25/34

LTFI Prevents Individuals From

Cancelling Their Flood Insurance Policy

Many homeowners cancel their flood policy if they have

not experienced a flood for several years.

Reason: Flood insurance was not a good investment.

Data: Of 1,549 victims of a flood in August 1998 in

northern Vermont, FEMA found 84% of residents in

SFHAs did nothave flood insurance, 45% of whom wererequired to purchase it (Tobin and Calfee, 2005).

25

T f N Fl d I P li i i


26/34

Tenure of New Flood Insurance Policies in

Mississippi

New BusinessYear 2001 2002 2003 2004 2005 2006 2007 2008

# New Housing Units 8,297 7,539 8,345 9,183 9,316 44,621 15,599 14,086

Tenure 100% 100% 100% 100% 100% 100% 100% 100%

1 year 73% 68% 65% 72% 66% 73% 72%

2 years 61% 51% 52% 45% 54% 62%

3 years 47% 42% 38% 37% 43%

4 years 39% 30% 32% 29%

5 years 25% 26% 27%

6 years 20% 22%

7 years 17%

Authors calculation Data from NFIP/FEMA


27/34

Outline of Talk






6. Encouraging Mitigation through LTFI: An Example

7. Summary

27


28/34

Characteristic of MitigationUpfront cost/long-term benefits

Cost of Mitigation $1,500 to strengthen roof of house

Nature of Disaster

1/100 chance of disaster

Reduction in loss ($27,500)

Expected Annual Benefits:

$275 (1/100 * $27,500)

Annual Discount rate of 10%

28

6. Encouraging Mitigation: An Example

28

Expected Benefit Cost Analysis of Mitigation


29/34

Benefits over 30 years

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

1 2 3 4 5 8 10 15 20 25 30

Upfront cost of mitigation

Expected Benefit-Cost Analysis of Mitigation

Years

R i l f L T Fl d I


30/34

Illustrative ExampleCost of partial roof mitigation: $1,500

Expected annual benefit of partial roof mitigation:

$275 (1/100 * $27,500)

Annual payments from 20 year $1,500 loan at10% annual interest rate: $145

Reduction in annual insurance payment: $275

Reduction in annual payments due to mitigation:$275-$145= $130

Rationale for Long-Term Flood Insurance

Encouraging Mitigation with Long-Term Loans

Linking Long Term Home Improvement Loans
http://www.photos.com/en/search/close-up?eqvc=138658&oid=2711945&a=&pt=&k_mode=all&k_exc=body&cid=&date=&ct_search=&k_var=roofer&bl=%2Fen%2Fsearch%2Findex%3Ff_h%3D1%26f_i%3D1%26f_o%3D1%26f_v%3D1%26f_b%3D1%26f_c%3D1%26k_exc%3Dbody%26k_var%3Droofer%26k_mode%3Dall%26big%3D1%26srch%3DSearching...%26&ofirst=&srch=Y&hoid=159d5d87d53b3019cf2f00042fa1cd69


31/34

31

Everyone is a Winner:

Homeowner:Lower total annual payments

Insurer:Reduction in catastrophe losses andlower reinsurance costs

Financial institution:

More secure investment due to lowerlosses from disaster

General taxpayer:Less disaster assistance

Linking Long-Term Home Improvement Loans

with Long-Term Flood Insurance


32/34

7. Summary

The Facts:

Totally new era of large-scale risks; huge and still growingconcentration of value in high-risk areas; indication of moredevastating disasters in the future.

The Reality:Need guiding principles for insurance and long-term contracts toincentivize investment in loss-reduction measures.

Research and policy questions:

How can we work together to develop long-term insurance andlong-term home improvement loans as part of the reform of theNFIP so we make more people protected at lower cost, reducefederal relief, and make our nation more resilient?

32


33/34

33


34/34

More about the Wharton Risk Center

http://opim.wharton.upenn.edu/risk

34
http://opim.wharton.upenn.edu/riskhttp://opim.wharton.upenn.edu/risk

Senator Wicker Roundtable

Documents

Transcript of Senator Wicker Roundtable