Howard Kunreuther and Erwann O. Michel-Kerjan from the Wharton School of the University of Pennsylvania make the case for long-term flood insurance in their paper "Market and Government Failure in Insuring and Mitigating Natural Catastrophes: How Long-Term Contracts Can Help", prepared for the American Enterprise Institute Conference on Private Markets and Public Insurance Programs, Wohlstetter Conference Center, Washington, DC January 15, 2009.
A coherent strategy is necessary to ensure a sustainable recovery from large-scale disasters and the appropriate future development of hazard-prone areas. But these issues are complex. They challenge our capacity as a nation to work together despite different agendas of key stakeholders and legislators regarding the role and responsibilities of the private and public sectors in dealing with catastrophic risks. Absence of leadership in this area will inevitably lead to unnecessary loss of lives and economic destruction in the devastated regions.
This paper complements other analyses ... by focusing on the risk of large-scale natural disasters, although we believe the concepts and proposals for managing these risks more effectively have relevance to other types of extreme events such as terrorism and catastrophic accidents.2 The paper is organized as follows. Section 2 discusses the evolution over the past four decades of economic and insured losses due to major catastrophes and the key drivers of this change. Section 3 proposes four guiding principles for developing sustainable insurance and mitigation programs. Section 4 focuses on the state of Florida as an example of how these principles have been violated to meet short-term objectives with respect to economic development. Section 5 focuses on the behavioral biases, notably myopia, that discourages individuals from investing in cost effective protective measures. Section 6 proposes long-term insurance contracts combined with long-term loans for overcoming these biases. The National Flood Insurance Program, which is due for renewal/changes by Congress in April 2009, is a natural candidate for these contracts as discussed in Section 7. The paper concludes with a brief summary and suggestions for future research.
“Insurance plays a vital role in America’s economy by helping households and businesses manage risks. (…) When insurance prices reflect underlying economic costs they can encourage a more efficient allocation of resources. Efforts to keep premiums for insurance against catastrophe hazards artificially low, whether through regulation or through subsidized government programs, can encourage excessively risky behavior on the part of those who might be affected by future catastrophes.”
Economic Report of the President (2007), pp.122-123.
(It is quite remarkable that 2007 was the first year that the Economic Report of the President devoted a chapter to catastrophic risk insurance.)
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