Howard Kunreuther

Mitigating Disaster Losses through Insurance

Losses from natural disasters have increased in recent years due to growth of population in hazard-prone areas and inadequate enforcement of building codes. This article first examines why homeowners have not voluntarily adopted cost-effective protective measures and have limited interest in purchasing insurance. It then proposes a disaster-management program which utilizes insurance coupled with well-enforced building codes to reduce future damage. Banks and financial institutions play a key role in this program by requiring inspections of homes as a condition for a mortgage. New forms of reinsurance coverage against catastrophic losses from natural disasters are necessary to protect insurers against potential insolvency from the next mega-disaster.

Sources of Bias in Assessment Procedures for Utility Functions

Utility functions are an important component of normative decision analysis, in that they characterize the nature of peoples risk-taking attitudes. In this paper we examine various factors that make it difficult to speak of the utility function for a given person. Similarly we show that it is questionable to pool risk-propensity data across studies (for descriptive purposes) that differ in the elicitation methods employed. The following five sources of bias or indeterminacy are hypothesized and demonstrated. First, certainty equivalence methods generally yield greater risk-seeking than probability equivalence methods. Second, the probability and outcome levels used in reference lotteries induce systematic bias. Third, combining gain and loss domains yields different utility measures than separate examinations of the two domains. Fourth, whether a risk is assumed or transferred away exerts a significant influence on peoples preferences in ways counter to expected utility theory. Finally, context or framing differences strongly affect choice in a nonnormative manner. The above five factors are first discussed as essential choices to be made by the decision scientist in constructing Von Neumann-Morgenstern utility functions. Next, each is examined separately in view of existing literature, and demonstrated via experiments. The emerging picture is that basic preferences under uncertainty exhibit serious incompatibilities with traditional expected utility theory. An important implication of this paper is to commence development of a systematic theory of utility encoding which incorporates the many information processing effects that influence peoples expressed risk preferences.

Decision processes for low probability events: Policy implications

This survey describes the impact of judgements and choices about low probability, high consequence events on the policymaking process. Empirical evidence indicates that normative models of choice, such as expected utility theory, are inadequate descriptions of individual choices. The ambiguity of low probabilities also affects decisions in ways that are not normative. Further, people exhibit biases in judgments about risks and probabilities. These findings have stimulated development of new theories, such as prospect theory and generalized utility theories incorporating attributes such as regret. The authors survey many of these empirical results and explore their implications for policy. They consider the role of information, economic incentives, compensation, and regulation in inducing socially desirable effects through the reframing of outcomes. They suggest that surveys and experiments can help analysts better understand the decision process for low probability events and design more effective public policies.

Risk, Ambiguity, and Insurance

In a series of experiments, economically sophisticated subjects, including professional actuaries, priced insurance both as consumers and as firms under conditions of ambiguity. Findings support implications of the Einhorn-Hogarth ambiguity model: (1) For low probability-of-loss events, prices of both consumers and firms indicated aversion to ambiguity; (2) As probabilities of losses increased, aversion to ambiguity decreased, with consumers exhibiting ambiguity preference for high probability-of-loss events; and (3) Firms showed greater aversion to ambiguity than consumers. The results are shown to be incompatible with traditional economic analysis of insurance markets and are discussed with respect to the effects of ambiguity on the supply and demand for insurance.

Disaster Resilience: A National Imperative

pled with the increasing frequency of billion-dollar disaster events, such as the recent Hurricane Sandy, highlight some of the challenges to hazards and disaster policy in the United States. American society is also facing challenges to its economic, sociocultural, and environmental systems: The national jobless rate is near historic high values, more than one in six Americans now live in poverty, population migration to the coastal communities continues, and environmental degradation due to development, farming practices, or industrial processes and accidents continues to degrade natural defenses against floods, storm surge, and wildfires. Many of these changes are transformative and long lasting and, coupled with the nation’s inability to act decisively to counteract climate change, portend a future where we are more vulnerable to hazards at multiple scales. Extreme natural events (either unprecedented magnitudes or intensities of natural hazards or the unprecedented consequences of more routine hazards) may become normal occurrences under changing climatic conditions or changes in economic circumstances and social conditions.1,2 Low-probability/high-consequence events and highly improbable ones like earthquakes, pandemics, and other kinds of hazards take on more policy interest as these events become more probable.3-5 From a policy perspective, these unlikely events pose significant risk management challenges, starting with how to encourage investments to lessen the impacts of these disasters (Figure 1). by Susan L. Cutter, Joseph A. Ahearn, Bernard Amadei, Patrick Crawford, Elizabeth A. Eide, Gerald E. Galloway, Jr., Michael F. Goodchild, Howard C. Kunreuther, Meredith Li-Vollmer, Monica Schoch-Spana, Susan C. Scrimshaw, Ellis M. Stanley, Sr., Gene Whitney, and Mary Lou Zoback

Cognitive Processes and the Decisions of Some Parents to Forego Pertussis Vaccination for Their Children

Public health analyses suggest that, in spite of the possibility that pertussis vaccine may cause rare cases of neurological injury, catastrophic risks to individual children are lower if they are vaccinated. A number of parents, however, choose not to vaccinate their children. The purpose of this study was to investigate the decision processes of some parents who choose to vaccinate and some parents who choose not to do so. Surveys were mailed to 500 randomly selected subscribers of Mothering magazine. Two hundred and ninety-four completed questionnaires were returned (59%). In addition to well-recognized factors in vaccination decisions, perceived dangers of the vaccine, and of the disease and susceptibility to the disease, several cognitive processes not previously considered in vaccination decision studies were found to be important predictors in this population of parents: perceived ability to control childrens susceptibility to the disease and the outcome of the disease; ambiguity or doubts about the reliability of vaccine information; a preference for errors of omission over errors of commission; and recognition that if many other children are vaccinated, the risk to unvaccinated children may be lowered. Although perhaps most cases of undervaccination for pertussis reflect more general problems of health care access, some parents choose to forego vaccination for their children for other reasons. Traditional risk-benefit arguments alone will be unlikely to persuade these parents to reassess their decisions. Efforts to increase childhood vaccination must incorporate an understanding of the cognitive processes that help drive these decisions.

Making Low Probabilities Useful

This paper explores how people process information on low probability-high consequence negative events and what it will take to get individuals to be sensitive to the likelihood of these types of accidents or disasters. In a set of experiments, information is presented to individuals on the likelihood of serious accidents from a chemical facility. Comparisons are made with other risks, such as fatalities from automobile accidents, to see whether laypersons can determine the relative safety of different plants. We conclude that fairly rich context information must be available for people to be able to judge differences between low probabilities. In particular, it appears that one needs to present comparison scenarios that are located on the probability scale to evoke peoples own feelings of risk. The concept of evaluability recently introduced by Hsee and his colleagues provides a useful explanation of these findings.

Neglecting Disaster: Why Don't People Insure Against Large Losses?

This paper provides a theoretical explanation for the common observation that people often fail to purchase insurance against low-probability high-loss events even when it is offered at favorable premiums. We hypothesize that individuals maximize expected utility but face an explicit or implicit cost to discovering the true probability of rare events. This cost constitutes a threshold that may inhibit purchase but may be offset in several ways by suppliers of insurers and state regulators.

Disaster Mitigation and Insurance: Learning from Katrina

Hurricane Katrina illustrates the natural disaster syndrome. Prior to a disaster, individuals in hazard-prone regions do not voluntarily adopt cost-effective loss reduction measures. The federal government then comes to the rescue with disaster assistance even if it claimed it had no intention of doing so prior to the event. There are a number of reasons why individuals do not protect themselves prior to a disaster. They underestimate the likelihood of a future disaster, often believing that it will not happen to them; have budget constraints; are myopic in their behavior; and/or do not want to be the only one on the block modifying their structure. Given this lack of interest in voluntary protection, benefit-cost analysis can determine when a well-enforced building code would be appropriate. The article concludes by highlighting the importance of public-private partnerships as a way of reducing future disaster losses and aiding the recovery process.

Paying the price : the status and role of insurance against natural disasters in the United States

This book considers the effectiveness of insurance coverage for low-probability, high-consequence events such as natural disasters--and how insurance programs can successfully be used with other policy tools, such as building codes and standards, to encourage effective loss reduction measures. The authors discuss the reasons for the dramatic increase in insured losses from natural disasters since 1989 and the concern that insurers have about their ability to provide coverage against more such events in the future. It addresses why there has been an increasing demand for hazards insurance, what types of coverage private insurers are willing to offer, and the role of reinsurance and private-/public-sector initiatives at the state and federal levels for providing protection to victims of natural disasters. Detailed case studies of the challenges facing Florida in the wake of Hurricane Andrew in 1992 and California following the Northridge earthquake in 1994 reveal the challenges facing the insurance industry as well as other concerned stakeholders. The National Flood Insurance Program illustrates how a public-/private-sector partnership can mitigate damages and provide financial protection to victims. The book identifies new initiatives for reducing future losses and providing funds for recovery through cooperation by the relevant parties.