Hurricane Bill: Who Should Pay?


Before Hurricane Hugo swept through Georgia and North and South Carolina in 1989, the insurance industry in the U.S. had never suffered a loss of more than $1 billion from a single disaster.

Hurricane Bill, the first Atlantic hurricane of 2009, now offers a vivid—and somber—reminder of the East Coast’s vulnerability to severe weather events, according to the Insurance Information Institute (I.I.I.).

Eight of the 10 costliest hurricanes in U.S. history, as defined by insured losses, have occurred since 2004. Hurricane Ike in 2008 ($12.5 billion) ranked third, topped only by Hurricane Katrina ($45.3 billion), which ranked first, while 1992’s Hurricane Andrew ($23.8 billion) ranked second, reports the I.I.I.

And while catastrophe and weather-related modelers are now fairly certain that Hurricane Bill, now weakened to a Category 3 hurricane, will not make full landfall in the United States, its projected path is running parallel to the high-risk coastline from the outer banks of North Carolina all the way up to New England, while remaining hundreds of miles away from land. If it does hit the U.S., it will do so in areas of increasing concentration of population.

Jeanne Salvatore, SVP and consumer spokesperson for the I.I.I., cautions against complacency. “Those who take the time to prepare for a disaster such as a hurricane stand the best chance of surviving the storm and getting back to their normal lives as quickly as possible.”

This is good advice for citizens and their safety, and good advice for insurers that hope for fewer insurance claims. Yet high-risk areas equate to higher premiums, and claims aside, the need to assess and manage risk effectively is still a hot topic.

In fact, residential and commercial development along coastlines and areas that are prone to earthquakes and floods suggest that future insured losses will only grow—a trend that emphasizes, as never before, the need to assess and manage risk on both a national and a global scale, notes The Wharton School at The University of Pennsylvania.

Tackling the more esoteric aspects of this topic, the authors of a new book titled, At War with the Weather: Managing Large-Scale Risks in a New Era of Catastrophes, pose one question:

Who should be forced to pay?

That question is offered at the outset of the book, written by Howard Kunreuther and Erwann Michel-Kerjan, with colleagues Neil Doherty, Martin Grace, Robert Klein and Mark Pauly, which analyzes current thinking about catastrophes, risk management and financial recovery.

The book also proposes new, long-term solutions for reducing loss and providing the necessary financial protection against future disasters. As one of the authors notes, "The question you have to ask yourself before reading the book is: How much are you willing to lose when the next catastrophe strikes?"

Kunreuther, professor of decision sciences and business and public policy, and co-director of Wharton's Risk Management and Decision Processes Center, has written at length on the risk management topic.

Despite record losses from hurricanes and other recent natural disasters, many still think we can continue to gamble with Mother Nature and win, notes Kunreuther, but we have now reached a breaking point because of the increasing concentration of population and activities in high-risk coastal regions of the country.

“We have raised that question right at the outset—who should pay?” he told the Wharton School in an interview.

“We are not necessarily going to provide an answer, because it depends on how society wants to treat this,” he continues. “If we believe we are all responsible, in some sense, for covering the losses of anyone living in an area, then all of us should be paying. If, on the other hand, we feel that it is important for people to take some responsibility and recognize that they are in harm's way and that there is a price to pay, then one has to somehow take the stand that the people in these areas should pay.”

Kunreuther notes that two principles that guide this book relate to the question.

“One principle is that if we are going to use insurance as a policy tool, then premiums should definitely reflect the risk, so people know whether or not they are in harm's way and have some indication of what that is,” he says. “And this also encourages people to invest in risk-reducing measures, because if the premiums reflect risk, people can get a discount [on their insurance premiums]; they can get something back if they take steps to reduce loss, which is not the case today.”

The second principle, notes Kunreuther, is that “we have to deal with equity and affordability.”

Kunreuther points to low-income people and others who need special treatment in these high-hazard areas, stating that if the premiums reflect the risk, then those premiums can be extraordinarily high, meaning some people might not be able to afford them.

“So our second principle advocates some kind of subsidy to these individuals,” he says. “But we do not want the subsidies to come through insurance premiums; we feel they should come through something like an insurance stamp, like we have food stamps today for low-income families. That means that the insurance can still reflect the risk. Those two principles guide almost everything we want to do with respect to policy.”

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