Learning from Catastrophes:
Strategies for Reaction and Response in Public Health
Howard C. Kunreuther
kunreuther@wharton.upenn.edu
Risk Management and Decision Processes Center
The Wharton School, University of Pennsylvania
http://opim.wharton.upenn.edu/risk
Crises as Catalyst in Public Health Seminar Series
September 13, 2010
45.0%
40.0%
Gross Loss
Exceedance Probability
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
$0
$10
$20
$30
$40
$50
Loss (in $ Billions)
$60
$70
$80
$90
$100
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 Talk
Part 1: Linking Risk Assessment and Risk Perception with Risk
Management: A Conceptual Framework for Studying Risk
1.
2.
3.
Risk Assessment and Vulnerability Analysis
Risk Perception and Choice
Risk Management Strategies
Part 2: Managing Catastrophic Risks in an Uncertain World
1.
2.
3.
4.
5.
6.
7.
A New Era of Catastrophes
Guiding Principles for Developing Risk Management Strategies
Benefits of Protective Measures
A New Proposal: Multi-Year Flood Insurance
Encouraging Protection: An Example
Future Research: Multi-Year Health Insurance with Short-Term
Incentives
3
Summary
A Conceptual Framework for Studying Risk
Risk Assessment
& Vulnerability
Analysis
Risk Perception and
Choice
Modeling
of Risks
Public Perceptions
Expert/Layperson Differences
Risk Communication
Statistical
Data Building
Scenarios
Risk Management Strategies
Public Private Partnerships
4
A Conceptual Framework for Studying Risk
Risk Management Strategies:
Public Private Partnerships
Information Provision
Incentives
Regulation
Standards
Compensation
Insurance
Liability
Evaluation of Strategies
Impact on Society
Impact on Interested Parties
5
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?
6
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
Probability
p(L) that losses
will exceed L
95%
Mean
5%
Loss, L (in dollars)
8
Risk Assessment and Vulnerability Analysis
Open 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 riskreducing 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?
9
2. Risk Perception and Choice
Basic Concepts
• 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
10
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.
11
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
12
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?
13
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
14
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?
15
Outline of Talk
Part 1: Linking Risk Assessment and Risk Perception with Risk
Management: A Conceptual Framework for Studying Risk
1.
2.
3.
Risk Assessment and Vulnerability Analysis
Risk Perception and Choice
Risk Management Strategies
Part 2: Managing Catastrophic Risks in an Uncertain World
1.
2.
3.
4.
5.
6.
Cause for Concern: A New Era of Catastrophes
Guiding Principles for Developing Risk Management Strategies
Benefits of Protective Measures
A New Proposal: Multi-Year Flood Insurance
Encouraging Protection: An Example
Future Research: Multi-Year Health Insurance with Short-Term
Incentives
7. Summary
16
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): $889 million in
damage (365% of GNP)
Victims complain about receiving substantially less than the actual
costs to repair or rebuild their damaged structures
Public sector and international organizations
(e.g., World Bank) are committed to providing
financial assistance to aid the victims of disasters
17
Worldwide Evolution of Catastrophe Insured Losses, 1970-2008
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
Man-made catastrophes
Natural catastrophes
9/11/2001 loss (property and BI)
9/11/2001 loss (liability and life)
2002
2004
2006
2008
18
(Property and business interruption (BI); in U.S.$ 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
The 25 Most Costly Catastrophe Insurance Losses, 1970-2008
(17 here in the U.S., 12 of these since 2001)
$ Billion
Event
46.3
Hurricane Katrina
35.5
9/11 Attacks
23.7
Hurricane Andrew
19.6
Northridge Earthquake
16.0
Hurricane Ike
14.1
Hurricane Ivan
13.3
Hurricane Wilma
10.7
Hurricane Rita
*
*
*
*
*
*
*
Victims (Dead or missing)
Year
Area of Primary Damage
1,836
2005
USA, Gulf of Mexico, et al.
3,025
2001
USA
43
1992
USA, Bahamas
61
1994
USA
348
2008
USA, Caribbean, et al.
124
2004
USA, Caribbean, et al.
35
2005
USA, Gulf of Mexico, et al.
34
2005
USA, Gulf of Mexico, et al.
24
2004
USA, Caribbean, et al.
51
1991
Japan
8.8
Hurricane Charley
8.6
Typhoon Mireille
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
*
*
*
19
What’s Happening?
The Question of Attribution
Higher degree of urbanization
Huge increase in the value at risk
Population 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 patterns
Changes 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 Paula
make landfall in the U.S. in 2010?
20
Insured Coastal Exposure as a Percentage of Statewide
Insured Exposure as of December 2007
(Residential and Commercial Properties)
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%
Source: Data from AIR Worldwide Corporation
21
Total Value of Insured Coastal Exposure
as of December 2007
(in $ billion; Residential and Commercial Properties)
$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
Source: Data from AIR Worldwide Corporation
22
AT WAR WITH THE WEATHER
July 2009 - MIT Press
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.
23
24
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.
25
Insurance Vouchers
Existing Programs as Models
Food Stamp Program
Mission: Vouchers to purchase food based on annual
income and family size
Low Income Home Energy Assistance Program
Mission: Assist low income households in meeting
immediate energy needs
Universal Service Fund
Mission: Provide discounts to low-income individuals in
rural areas so rates for telecommunications services are
comparable to urban areas
26
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 with insurance
Residents in coastal areas – Those in hurricane-prone areas
27
3. Benefits of Protective Measures
Effects of Mitigation on a 500 Year Event
On a 500-Year Event
180
$160 billion loss
160
140
$82 billion saving with
Adaptation measures in place
Losses (Billions)
120
100
Savings from Mitigation
Remaining Losses
80
60
40
20
0
FL
NY
SC
State
TX
28
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)
29
4. A New Proposal: Multi-Year Flood Insurance
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
30
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
31
5. Encouraging Protection: An Example
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%
32
Expected Benefit-Cost Analysis of Mitigation
Benefits over 30 years
$3,000
$2,500
$2,000
$1,500
Upfront cost of mitigation
$1,000
$500
$0
1
2
3
4
5
8
10
15
20
25
30
33
Rationale for Multi-Year Flood Insurance
Encouraging Mitigation with Multi-Year Loans
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
34
Linking Multi-Year Home Improvement Loans
with Multi-Year Flood Insurance
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
35
35
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
36
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
37
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?
38