The Economics of Natural and Unnatural Disasters.
Several high-profile disasters have rocked the world in recent years. The 2010 Haitian earthquake killed over 200,000 people, and the 2011 tsunami in Japan destroyed several hundred billion dollars of property and resulted in tens of thousands of deaths. Before these tragedies, Hurricane Katrina leveled much of New Orleans.
With questions of how to plan for and rebuild from these natural disasters firmly in the public eye, William Kern has assembled a very timely volume that should help inform the debate. Tackling topics ranging from assessments of public policy's impact on disaster planning to the costs incurred in current tornado avoidance practices, The Economics of Natural and Unnatural Disasters surveys several areas of interest in a manner most ideal for those looking for an accessible introduction to disaster economics.
After an introduction by editor Kern summarizing the work to follow, Chapter 2 begins with an essay by Howard Kunreuther and Erwann Michel-Kerjan advocating long-term contracts for natural disaster insurance. The authors begin by noting the increasing relevance of natural disaster insurance due to a trend toward urbanization and general movement to hazard-prone coastal counties, which raises the damages associated with any particular natural disaster. Kunreuther and Michel-Kerjan also argue that, given trends over recent years, climate change will trigger more disasters in these areas, thus making insurance even more important. While this point is debatable, considering other researchers (e.g., Pielke, 2005) find no increasing trend in hurricane destructiveness after accounting for urbanization and movement toward coasts, the underlying idea--that the need for disaster insurance is becoming more prominent--is a good one. The authors then proceed with a novel recommendation: long-term disaster insurance contracts that, when signed, attach to the property and bind both homeowners and insurers to a fixed premium for a defined period of 10 or 25 years. Such contracts prevent suboptimal levels of insurance from homeowners regularly underestimating the chance of a disaster, coupled with short time horizons or budget constraints. Long-term contracts bind the homeowner to coverage, at the same time avoiding the contracting costs associated with annual policies and lengthening homeowners' time horizons to undertake efficient preventative measures that pay back only over the long term. In the authors' view, a particularly promising chance to implement this policy is the national flood insurance program.
The authors provide only enough of the picture to be provocative and encourage thought along unconventional lines. Several questions arising from a binding longterm disaster insurance policy spring to mind: Why is the time horizon alignment to ensure efficient preventative measures necessary for natural disaster insurance but not other insurance lines, such as property, health, or automobile insurance? With insurance contracts attached to property, what can a buyer do and who would best be served by greater or less coverage? And will consumers react to long-term fixed rates by submitting more claims with the knowledge that insurers cannot respond by raising prices? As the authors further develop this exciting topic, no doubt we will find answers to these questions and more.
In the next chapter, Anthony Yezer contributes insights into economic effects from changes in expectations of disasters. Yezer first discusses how property values incorporate disaster expectations, which are generally based on past natural disaster experience. As disasters increase or decrease in occurrence rate or severity, these expectations shift over time. However, property values cannot factor in unexpected disasters, so it is precisely these disasters that can cause the most economic harm. Perhaps most troubling, these disasters cannot be insured against because they are unexpected, leading Yezer to advocate federal assistance in these cases. Yezer makes other interesting arguments in this section as well. First, private considerations alone result in too little development of urban hazard-prone areas. And second, mandatory disaster insurance (such as flood insurance) should be instituted with care, since there may be cases where individuals in a hazard-prone area actually benefit from a disaster and so might be better self-insuring rather than being forced to purchase insurance and pay the insurer's policy administration costs. As an example of this latter point, Yezer points to beachfront communities, in which property two to three rows removed from beachfront property may benefit if a storm decimates the area and, in addition to leveling houses, washes away the first row of land, effectively moving the beachfront line back. Even in this case, and not discussed by Yezer, insurance held by those whose property value rises may play an important role in providing the liquidity to rebuild a destroyed house on the now more valuable second- or third-row land without having to borrow against this increased value, so it is not immediately clear that compulsory insurance imposes enough costs to merit some of Yezer's concerns.
Hal Cochrane in Chapter 4 provides a brief discussion of disaster economics' origins and shows how the basic principles can be applied to modern issues such as carbon dioxide emissions. While the overview is somewhat abbreviated, several useful citations to foundational pieces in the literature are provided for those seeking additional depth. Cochrane concludes his section with a presentation of a modified input/output model to use when analyzing the economic effects of natural disasters. This type of model incorporates area- and disaster-specific characteristics and the effects of postdisaster bottlenecks in the production process that other types of models, such as simple econometric or computable general equilibrium, may find difficult to include.
In Chapter 5, Peter Boettke and Daniel Smith consider the often-overlooked role of private actors in disaster response. Focusing on the case of Hurricane Katrina, Boettke and Smith contrast the negative influence of government officials in preand postdisaster roles with the positive effects of for-profit, nonprofit, and religious groups. Although the authors may push too strongly for suspending zoning and construction regulations following disasters, their points about respecting the role of nongovernmental actors and particularly the positive effects of for-profit corporations responding to accurate price signals are well taken and should be kept in mind when planning postdisaster relief efforts.
Finally, Daniel Sutter and Kevin Simmons conclude the book with a stimulating analysis of the economic effects of tornadoes and tornado damage mitigation systems. In their discussion, the authors raise several points reminding the reader that disaster prevention policies must not concentrate only on maximizing the savings from avoided disasters but also must include the costs, both direct and indirect, associated with prevention efforts. In the case of tornadoes, the authors point out that significant costs arise from time spent under tornado warnings, thus suggesting the opportunity for large savings if the warning process can be refined in geographic and temporal scope. In addition, recent construction developments that have produced tornado-proof shelters also carry costs. The authors estimate these costs at over $50 million per potential life saved, leading them to question whether these shelters should be used. Sutter and Simmons conclude the chapter with an analysis of various factors' relationships with tornado losses, including the effect of time of day or year the tornado occurs and the advance notice provided by tornado warnings. This chapter does an excellent job of highlighting the point that complete disaster damage prevention should not necessarily be the relevant policy goal; instead, balancing these savings against prevention costs will result in an efficient, if not total, level of prevention.
The Economics of Natural and Unnatural Disasters has collected a series of essays that cover several distinct areas of disaster economics and serve as a worthy introduction to the area. While some readers more familiar with the field or in search of rigorous treatment of these topics may benefit from exploring the contributors' more complete publications, many will appreciate this survey of important issues in disaster insurance. Kern has done an admirable job of assembling an interesting read that should help stimulate discussion in this interesting and increasingly relevant field.
Pielke, R. A., 2005, Meteorology: Are There Trends in Hurricane Destruction? Nature 438(7071): E11.
Reviewer: Peter Molk, J.D. Yale Law School, M.A. Yale Economics Department, New Haven, CT; firstname.lastname@example.org
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|Publication:||Journal of Risk and Insurance|
|Date:||Dec 1, 2011|
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