risk management | November 25, 2012

Catastrophe Lessons from Sandy: Erwann Michel-Kerjan's NYT Op-Ed

"Hurricane Sandy could cost the nation a staggering $50 billion," Erwann Michel-Kerjan and Howard Kunreuther  write in the New York Times. They add: "to date [it is] the most costly disaster in United States history...but Hurricane Sandy was not an isolated event." As Michel-Kerjan, a risk management expert, explains in the article, the incidence of major disasters has been increasing rapidly. 30 of the world's most expensive insured catastrophes occurred between 1970 and 2011 with 20 of them occurring since 2001 and 13 taking place in the United States. North Americans can no longer afford to not be prepared for a catastrophic disaster, he writes, even though they don't believe that one will "happen to them."

"For families and businesses, insurance plays an important role in assisting financial recovery," Michel-Kerjan explains. "However many people, including those in high-risk areas, don’t have coverage...ninety percent of Californians, for example, are without earthquake coverage." He also notes that half of policyholders cancel flood coverage after going a few years incident-free. Why? "Because they paid premiums without getting anything in return and are likely to think 'Bad investment!'" He argues that insurance is not an investment, but rather, a safety net that helps to prevent people from relying on friends, family and over-extended government grants to bail them out when a disaster hits and they aren't covered. However, Michel-Kerjan and Kunreuther (both teachers at the Wharton School of the University of Pennsylvania and co-authors of At War with the Weather) also argue that there are problems with the way that insurance policies are run.

Their first point is that "premiums should reflect risk." This could help expose people to the potential dangers of living in a certain location or type of dwelling, halt construction of new buildings in high-risk places and encourage people to improve the stability of their homes in favor of receiving a reduced rate. They also propose a "federal disaster insurance means-tested voucher program," that would operate similar to the food stamp program to provide coverage to those living in high-risk areas who cannot afford to purchase their own insurance. Finally, they suggest that people lock into insurance contracts at a fixed rate so that they are less likely to opt of their policies when a few years go by and they haven't been hit with a disaster. On the whole, they also advocate for a presidential commission to be implemented with the purpose of reworking the disaster financing strategy of the nation. By addressing these issues now, rather than later, Michel-Kerjan argues that the nation will be better prepared for disasters, and be able to recover—and prosper—much more quickly.

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innovation | November 22, 2012