Learning from Catastrophes: Strategies for Reaction and Response in

Public Health

Howard C. Kunreuther kunreuther@wharton.upenn.edu

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

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

Crises as Catalyst in Public Health Seminar Series September 13, 2010

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Summary of Key Points

Individuals focus on short-term horizons• Want immediate return from their preventive measures

• Often regard potential disasters as below their threshold of concern

Impact of this behavior• Failure to take protective measures prior to a disaster

• Cancel insurance if one doesn’t make a claim for a few years

Proposed strategy• Well-enforced long-term contracts

• Short-term economic incentives to deal with myopia 2

Outline of TalkPart 1: Linking Risk Assessment and Risk Perception with Risk

Management: A Conceptual Framework for Studying Risk 1. Risk Assessment and Vulnerability Analysis

2. Risk Perception and Choice

3. Risk Management Strategies

Part 2: Managing Catastrophic Risks in an Uncertain World 1. A New Era of Catastrophes

2. Guiding Principles for Developing Risk Management Strategies

3. Benefits of Protective Measures

4. A New Proposal: Multi-Year Flood Insurance

5. Encouraging Protection: An Example

6. Future Research: Multi-Year Health Insurance with Short-Term Incentives

7. Summary

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A Conceptual Framework for Studying Risk

Statistical Data Building

Scenarios

Risk Perception and Choice

Public Perceptions Expert/Layperson Differences Risk Communication

Risk Assessment& Vulnerability

Analysis

Modelingof Risks

Risk Management Strategies Public Private Partnerships

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Risk Management Strategies:Public Private Partnerships

Information Provision Incentives Regulation Standards Compensation Insurance Liability

Evaluation of Strategies Impact on Society Impact on Interested Parties

A Conceptual Framework for Studying Risk

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1. Risk Assessment and Vulnerability Analysis

Risk Assessment– Encompasses estimates of both the chances of a specific set of events occurring

and their potential consequences– Experts differ in their estimates of the risk– Find your favorite expert to support your position

Vulnerability Analysis– Characterize forms of physical, social, political, economic, cultural, and

psychological harms to which individuals and modern societies are susceptible– Millions of dollars have already been spent to reduce our vulnerability

Constructing Scenarios – What are the probabilities of specific events?– What are the potential consequences?

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Risk Assessment Questions to Ponder

• What are the chances that New Orleans will have a Category 3 or higher hurricane in the next 5 years, and what would be the resulting damage and health impacts?

• What are the chances that there will be another severe oil spill in the U.S. in the next 5 years and what would be the health and environmental impacts?

• What are the chances of a swine flu pandemic in 2011 and how serious would the consequences be?

• What are the chances that there will be a smallpox epidemic in the United States in the next five years, and how many people would be affected?

Using Exceedance Probability Curves to Depict Risk

Uncertainty in Probability

Uncertainty in Loss

95%

Mean

Probability p(L) that losses will exceed L

5%

Loss, L (in dollars)8

Risk Assessment and Vulnerability AnalysisOpen Issues and Questions

• How accurately can experts estimate the likelihood and consequences of damage, injuries and fatalities from disasters of different magnitudes and intensities?

• Can one characterize the types of uncertainties that currently exist in assessing risk and suggest ways to improve these estimates in the future?

• What are the expected costs and benefits of undertaking specific risk-reducing measures in disaster-prone areas and can one rank them on the basis of cost effectiveness?

• What are the interdependencies in the system (e.g. infrastructure damage affecting supply of electricity, water, telephone/telecommunications, and other services to residences and businesses) and what are their impacts on indirect damage, health and environment?

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• Individuals exhibit systematic biases in processing information and making choices

– Estimating likelihood of event is influenced by salience

– “It cannot happen to me” before a crisis or disaster occurs

– “It will happen to me” immediately after a crisis or disaster

– “I don’t have to worry” a few months after a crisis or disaster

• Individuals have difficulties learning due to biases and information processing limitations

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2. Risk Perception and Choice Basic Concepts

Explain this behavior:

• I bought my first set of battery cables only after my car wouldn’t start and I had to be towed. The towing charge was twice as much as the cost of the battery cables.

• Most homeowners in California purchase earthquake insurance only after they experienced a quake. When asked whether the probability of a future event was more likely than before the disaster most people responded “Less likely.”

• Until seat belt laws were instituted in the United States, most drivers refused to wear them. When asked why they did not, a typical response was, “I won’t have an accident.” This response is consistent with the well-documented finding that 90% percent of all drivers feel they are better than the average driver.

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Stigmatization and Social Amplification of Risk

The Alar Case• No scientific evidence that Alar was carcinogenic

Were based upon animal studies that were considered suspect because the doses used had been so large as to have been acutely toxic.

No evidence from epidemiological studies showing Alar to be a human carcinogen.

• The reaction by the public to Alar illustrates social amplification of risk

Media amplified the risk and effectively stigmatized the product

Millions of consumers stopped buying apples and apple products after CBS news story on “60 Minutes” stated Alar could cause cancer

Convincing my wife that children from birth to 3 could drink apple juice with Alar

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Risk Perception and Choice Open Issues and Questions

• What role do perceived likelihoods and resulting consequences play in how people view a particular risk that they may face, such as a severe hurricane or a flu pandemic?

• How important are emotional factors such as fear, dread and anxiety in how people perceive these risks and learn over time?

• What role do social networks and social norms play in influencing risk perception, choice, and learning with respect to low probability events?

• How can one best communicate information to those at risk so they are aware of what actions they can take prior to and after a crisis or disaster?

• What is the role of past experience and the media in influencing risk perception and choice?

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3. Risk Management Strategies Basic Concepts

Policy options for reducing losses and aiding recovery process– Economic incentives– Insurance– Well-enforced regulations and standards (e.g., building codes)– Assistance following a disaster or crisis

Relevant roles of public and private sectors in implementing hazard management strategy

Criteria for evaluating alternative strategies– Efficiency -- allocating resources to maximize social welfare– Equity -- concern with fairness and distribution of resources

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Risk Management Strategies Open Issues and Questions

• What type of economic incentives would encourage individuals to mitigate the risks of a disaster and purchase insurance prior to a disaster?

• How does the prospect of federal aid to victims affect protective decisions by individuals prior to a disaster?

• What are the appropriate roles of standards and regulations in reducing losses from large scale disasters and the impact of the event following the disaster?

• What types of financial backstops should be provided by the public sector at the state and federal levels for dealing with catastrophic losses following future disasters?

• How can one link different policy tools such as information provision, economic incentives, insurance, third party inspections, regulations and standards to achieve the desired objectives of a hazard management strategy?

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Outline of TalkPart 1: Linking Risk Assessment and Risk Perception with Risk

Management: A Conceptual Framework for Studying Risk 1. Risk Assessment and Vulnerability Analysis

2. Risk Perception and Choice

3. Risk Management Strategies

Part 2: Managing Catastrophic Risks in an Uncertain World 1. Cause for Concern: A New Era of Catastrophes

2. Guiding Principles for Developing Risk Management Strategies

3. Benefits of Protective Measures

4. A New Proposal: Multi-Year Flood Insurance

5. Encouraging Protection: An Example

6. Future Research: Multi-Year Health Insurance with Short-Term Incentives

7. Summary

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1. Cause for Concern: A New Era of Catastrophes

A radical change in the scale and rhythm of catastrophes

Natural disasters have caused large numbers of fatalities and destruction in recent years• Cyclone Nargis (Myanmar, May 2008) : 140,000

fatalities • Sichuan Earthquake (May 2008) : 70,000

fatalities and 5 million residents were homeless • Hurricane Ivan (Grenada, September 2004): $889

million in damage (365% of GNP)

Victims complain about receiving substantially less than the actual costs to repair or rebuild their damaged structures

Public sector and international organizations (e.g., World Bank) are committed to providing financial assistance to aid the victims of disasters 17

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

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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)

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The 25 Most Costly Catastrophe Insurance Losses, 1970-2008

(17 here in the U.S., 12 of these since 2001) $ Billion Event Victims (Dead or missing) Year Area of Primary Damage

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

35.5 9/11 Attacks 3,025 2001 USA

23.7 Hurricane Andrew 43 1992 USA, Bahamas

19.6 Northridge Earthquake 61 1994 USA

16.0 Hurricane Ike 348 2008 USA, Caribbean, et al.

14.1 Hurricane Ivan 124 2004 USA, Caribbean, et al.

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

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

8.8 Hurricane Charley 24 2004 USA, Caribbean, et al.

8.6 Typhoon Mireille 51 1991 Japan

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

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

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

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

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

5.6 Hurricane Frances 38 2004 USA, Bahamas

5.0 Winterstorm Vivian 64 1990 Western/Central Europe

5.0 Typhoon Bart 26 1999 Japan

5.0 Hurricane Gustav 2008 USA, Caribbean, et al.

4.5 Hurricane Georges 600 1998 USA, Caribbean

4.2 Tropical Storm Allison 41 2001 USA

4.2 Hurricane Jeanne 3,034 2004 USA, Caribbean, et al.

3.9 Typhoon Songda 45 2004 Japan, South Korea

3.6 Thunderstorms 45 2003 USA

3.5 Hurricane Floyd 70 1999 USA, Bahamas, Columbia

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Higher degree of urbanization

Huge increase in the value at riskPopulation of Florida 2.8 million inhabitants in 1950 -- 6.8 million in 1970 -- 13 million in 1990

19.3 million population in 2010 (590% increase since 1950)

Cost of Hurricane Andrew in 2004 would have been $120bn

Weather patternsChanges in climate conditions and/or return to a high hurricane cycle?

More intense weather-related events coupled with increased value at risk will cost more, much more.

Will Hurricane Nicole, Otto or Paulamake landfall in the U.S. in 2010? 20

What’s Happening? The Question of Attribution

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Source: Data from AIR Worldwide Corporation

79%

64%62%

59%54%

36%35%

34%29%

28%26%

23%13%

12%11%

9%5%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Insured Coastal Exposure as a Percentage of Statewide Insured Exposure as of December

2007 (Residential and Commercial Properties)

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$2,458bn $2,378bn

$895bn $773bn

$635bn $480bn

$224bn $192bn

$159bn $147bn $133bn

$92bn $86bn

$61bn $56bn $54bn $52bn

0 250 500 750 1,000 1,250 1,500 1,750 2,000 2,250 2,500 2,750

Total Value of Insured Coastal Exposure as of December 2007

(in $ billion; Residential and Commercial Properties)

Source: Data from AIR Worldwide Corporation

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AT WAR WITH THE WEATHER

 

A better understanding of how individuals decide whether or not to protect themselves against natural disasters.

 

A set of guiding principles for using insurance to deal more effectively with these events.

 

Key lessons from the financial management of natural disasters to be applied to other global risks such as pandemics, financial crises and terrorism.

 

Ideas for the private sector, and sustainable public policy solutions to protect trillions of dollars of assets and the residents at risk in hazard-prone regions.

July 2009 - MIT Press

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2. Guiding Principles for Developing Risk Management Strategies

Principle 1: Premiums reflecting risk Insurance premiums should be based on risk in order to provide signals to

individuals as to the hazards they face and to encourage them to engage in cost-effective adaptation measures to reduce their vulnerability to catastrophes. Risk-based premiums should also reflect the cost of capital insurers need to integrate into their pricing to assure adequate return to their investors.

Principle 2: Dealing with equity and affordability issues

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

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Insurance VouchersExisting Programs as Models

Food Stamp Program Mission: Vouchers to purchase food based on annual income and family size

Low Income Home Energy Assistance ProgramMission: Assist low income households in meeting immediate energy needs

Universal Service FundMission: Provide discounts to low-income individuals in rural areas so rates for telecommunications services are comparable to urban areas

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Insurance VouchersWho 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 with insurance

Residents in coastal areas – Those in hurricane-prone areas

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Effects of Mitigation on a 500 Year Event

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Savings from Mitigation

Remaining Losses

$160 billion loss

$82 billion saving with$82 billion saving withAdaptation measures Adaptation measures

in placein place

3. Benefits of Protective Measures On a 500-Year Event

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Why Individuals Do Not Invest in Cost-Effective Protective Measures

Short Time Horizons (Quick return on investment)

High Short-Term Discount Rates (Hyperbolic discounting)

Misestimating Probability (“It 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 (Can’t recover costs of adaptation)2929

Proposed strategy

Multi-year flood insurance contracts through the National Flood Insurance Program (NFIP)

Multi-year home improvement loans for mitigating one’s property

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

4. A New Proposal: Multi-Year Flood Insurance

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Multi-Year Flood Insurance 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 and hurricanes

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Characteristic of Protective Measures Upfront cost/Multi-Year 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%

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5. Encouraging Protection: An Example

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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 benefits over time

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Illustrative Example Cost 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 at 10% annual interest rate: $145

Reduction in annual insurance payment: $275

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

Rationale for Multi-Year Flood Insurance

Encouraging Mitigation with Multi-Year Loans

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Everyone is a Winner:

Homeowner: Lower total annual payments

Insurer: Reduction in catastrophe losses and

lower reinsurance costs

Financial institution: More secure investment due to lower

losses from disaster

General taxpayer: Less disaster assistance

Linking Multi-Year Home Improvement Loans

with Multi-Year Flood Insurance

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6. Future Research: Multi-Year Health Insurance

with Short-Term Incentives for Better Health

(joint project with Mark Pauly and Kevin Volpp)Question: How can we encourage individuals to adopt better

health habits?

Findings: (Volpp et al. 2008; Volpp et al. 2009) – Economic incentives induce people to stop smoking and induce

obese individuals lose weight

– When incentives are removed, some people resume bad habits

Proposal: Multi-year insurance with premiums reflecting risk, and health insurance vouchers for those requiring special treatment– Premium reductions if you adopt better health habits

– Premium increases if you don’t maintain better health habits

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Example: Encouraging Weight Loss in Obese Individuals

Current Status of Individual A

Weight 250 lbs; Health Insurance Premium $1,000

Economic Incentive System for Individual A

Lose 20 pounds 2011; Premium lowered to $800

Maintain weight in 2012; Premium remains at $800

Lose 5 pounds in 2012; Premium lowered to $750

Gain 5 pounds in 2012; Premium raised to $850

 Note: Health insurance encourages better habits in much the same way that property insurance would encourage investing in cost-effective protection

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7. Summary

The Facts: Totally new era of “large-scale risks”; huge and still growing concentration of value in high-risk areas; indication of more devastating disasters in the future with property and environment damage and health impacts

The Reality: Individuals are myopic and misperceive risks, so they do not adopt cost-effective protective measures.

Research and policy questions: Is multi-year insurance coupled with short-term incentives a way to encourage adoption of protective measures to reduce future damage and health risks?What are the challenges and opportunities of developing specific proposals so they have a chance of being implemented?

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