THE NATION'S FIRST NATURAL hazards assessment got under way in 1972 at the Institute of Behavioral Science at the University of Colorado. Funded by the National Science Foundation and led by geographer Gilbert White and sociologist J. Eugene Haas, it was an interdisciplinary effort involving scores of policymakers, practitioners, and scholars from across the nation. Its purpose was to assess our knowledge about natural hazards and disasters, to identify major needed policy directions, and to inventory future research needs. The volume summarizing this endeavor, Assessment of Research on Natural Hazards in the United States, published in 1975, was a landmark in what was then a new field of study.

A quarter of a century later we find ourselves in a national conversation about how natural hazards mitigation can result in disaster-resilient communities. This conversation began in the early 1990s among a few individuals working in federal agencies and academia, and was articulated at a workshop in Estes Park, Colorado, in 1992, which was attended by many of the nation's leading natural hazards experts. They concluded that a second assessment of

hazards in the United States was needed, and that its unifying theme should be sustainable development, or development that enhances the capacity of the planet to provide a high quality of life now and in the future. A subsequent workshop in 1994 brought many of the same experts together to discuss and formulate an agenda for this second hazards assessment.

This book, which ensues from the second natural hazards assessment, is one of a series of books published by the Joseph Henry Press. A select group of experts were invited to expand upon their necessarily condensed contributions to the second assessment by developing individual works on major themes in the natural hazards and disasters field, including land use management, risk assessment, disaster preparedness and response, and mapping. This volume on natural hazards and insurance was written by a group headed by Howard Kunreuther, of the Wharton School's Risk Management and Decision Processes Center.

Paying the Price examines the roles of private and public insurance in dealing with natural disasters, discussing insurability conditions for natural disasters; the changing demand for residential disaster insurance in the United States; the challenges insurers face in providing insurance from earthquakes, hurricanes, and floods; and the functions of state insurance regulators. The book describes varying levels of state and federal involvement in insurance programs as exemplified by the California Earthquake Authority, Florida Hurricane Catastrophe Fund, and the National Flood Insurance Program. The authors take the position that the economic costs of natural disasters are too high and likely to soar in the future unless steps are taken to change recent trends. They discuss the role that insurance and mitigation together can play in reducing future losses from natural disasters. The program they propose for reducing disaster losses and financing recovery is characterized by joint efforts between insurers and other stakeholders, and by the use of strategies that combine insurance with monetary incentives, fines, tax credits, well-enforced building codes, and land use regulations.

The second national natural hazards assessment was funded by the National Science Foundation under Grant Number 93-12647, with supporting contributions from the Federal Emergency Management Agency, the U.S. Environmental Protection Agency, the U.S. Forest Service, and the U.S. Geological Survey. The support of these agencies is greatly appreciated. However, only the authors are responsible for the information, analyses, and recommendations contained in this book. Very

special thanks are extended to J. Eleonora Sabadell and William A. Anderson of the National Science Foundation for placing their confidence in us to carry out this mission.

DENNIS S. MILETI, Director

Natural Hazards Research and Applications Information Center University of Colorado at Boulder

THIS BOOK IS ABOUT THE ROLE that insurance, in combination with other policy tools, can play in reducing losses from natural disasters and in providing financial protection for those who suffer property damage from disasters. When we began this study four years ago, the insurance and reinsurance industries were reeling from the catastrophic losses many firms had experienced from Hurricane Andrew in Florida (August 1992) and the Northridge earthquake in California (January 1994). Many in the industry had grave doubts about whether insurers and reinsurers could continue to provide protection against wind damage from hurricanes and shake losses from earthquakes. At around the same time, other positive developments promised to aid insurance firms in offering coverage against these risks. Science and engineering research studies were yielding more accurate information on the probability and consequences of disasters of different magnitudes. New advances in information technology enabled large databases on population and property at risk to be manipulated more easily and rapidly than in the past. Insurers and reinsurers were beginning to employ catastrophe

modeling when determining the type of risks to include in their portfolios.

It is against this backdrop that this study was initiated as part of Dennis Mileti's broad-based second assessment of natural hazards. Our purpose was to bring together the country's leading experts on insurance and reinsurance to examine how insurance and reinsurance have provided protection against natural disasters in the past, and how they can play a more creative role in the future. There was general agreement among these experts that insurance can form the cornerstone of a disaster management program. However, there was also consensus that, to be successful in this regard, insurance has to be closely tied to other policy tools such as incentives, fines, tax credits, well-enforced building codes, and land use regulations. Furthermore, the insurance and reinsurance industry needs to work closely with other parties concerned with natural hazards, notably banks and financial institutions, the real estate and construction industries, and public sector agencies at the local, state, and federal levels.

The first three chapters of the book provide a general overview of the problem of dealing with low-probability, high-consequence events, the nature of the supply of insurance, and the demand for insurance against natural hazards. The middle portion of the book focuses on three case studies: the earthquake risk in California, the hurricane risk in Florida, and the changes in the National Flood Insurance Program over time. The final portion of the book focuses on strategies and institutional arrangements for reducing losses from natural disasters: the role of hazard mitigation coupled with insurance, the nature of insurance regulation, and a proposed program for reducing losses from natural disasters.

The principal focus of this book is on the impact that natural hazards have on the residential sector. The insurance crises in Florida, California, and other states were triggered by public concern that many insurers would discontinue providing homeowners with coverage against natural hazards. We recognize the importance of the commercial sector, and include a review of the availability of insurance for commercial property as Appendix A. At various points in the book, the authors note the great potential of catastrophe risk models in evaluating potential losses from natural hazards; a perspective on the challenges and opportunities of these models is provided in Appendix B.

This book examines a number of new developments in the insurance industry. The formation of public-private partnerships, as epitomized by the California Earthquake Authority at the end of 1996, is one example.

Continued change is inevitable. To help readers keep abreast of change in this field, we list a set of World Wide Web links to topics covered in the text, and describe in detail in Appendix C some key sites currently on the Web.

Many individuals have contributed to this book in a number of different ways. Those providing relevant material that was particularly useful to the principal authors are noted in footnotes at the beginning of each chapter. After a first draft of the book was produced, Richard Roth, Sr., worked closely with Robert DeChant and Don Seagraves in editing the material for style and consistency. DeChant was also responsible for the glossary of insurance-related terms.

At the Hazards Research and Applications Workshop in Boulder, Colorado, in July 1996, an early draft of the book was critiqued by a panel consisting of Jack Nicholson, Ellen Seidman, French Wetmore, and Eldon Ziegler, all of whom provided very helpful comments. In addition, we received helpful suggestions on drafts of different chapters from Jim Ament, Hal Cochrane, Clem Dwyer, Baruch Fischhoff, Jerry Foster, Rachelle Holland, Mark Johnson, Bill Martin, Mary Fran Meyers, Elliott Mittler, Tad Montress, Sean Mooney, John Mulady, Frank Nutter, George Segelken, Craig Taylor, Jeff Warren, Gilbert F. White, and Berry Williams.

In the course of writing this book, the authors had many helpful discussions on the issues associated with insurance and natural hazards with colleagues in both the academic community and the insurance world. Special thanks go to Ken Arrow, Ray Burby, Karen Clark, Graham Cook, David Cummins, Neil Doherty, Weimin Dong, Ron Eguchi, Ken Froot, Steve Goldberg, Robert Irvan, Gil Jamieson, Dan Kahneman, Paul Kleindorfer, Dennis Kuzak, Larry Larson, Scott Lawson, Chris Lewis, Peter May, Richard Moore, Ayse Onculer, Mark Pauly, Tony Santomero, Tom Schelling, Cliff Smith, Tom Tobin, Susan Tubbesing, Randy Updike, Susan Wachter, Sid Winter, Richard Zeckhauser, and Art Zeizel.

The production of this book was a collaborative effort on many fronts. Stephen Mautner, executive editor of the Joseph Henry Press, was extremely open to new ideas in producing this book and encouraged us from the outset to be creative in the use of graphs, photos, and maps to illustrate key points. Sharon Bolton, Walter Hays, and Ed Pasterick helped us to find disaster photos; Scott Lawson, Ed Pasterick, and Bob Klein were responsible for the maps included in the book. On the editorial side, Ann Perch and Marcia McCann worked closely with us in

copyediting the book; we are very grateful to them for spending weekends and late hours to help us make our deadlines while remaining cheerful in the process. We are also indebted to Anne Stamer, who, with efficiency and good humor, coordinated the entire effort with the many coauthors throughout the four years of this project.

A special note of appreciation to Dennis Mileti, who made this whole project possible: his vision of the second natural hazards assessment, plus his tireless efforts in assisting each of the many subprojects under this banner, enabled us to move forward on our individual efforts. He also graciously provided us with financial support for meetings and editorial assistance through his National Science Foundation (NSF) Grant. We also want to thank William Anderson for his encouragement and support of this effort. Partial funding from an NSF grant (# 524603) to the University of Pennsylvania and from the Wharton Risk Management and Decision Processes Center at the University of Pennsylvania is gratefully acknowledged.

Finally we want to thank our wives, Gail and Liz, respectively, for being active commentators on the project since its inception. They helped us to better understand the challenges in communicating information on a topic that is not part of normal conversation at the dinner table or at social gatherings. We hope the excitement that our entire group feels about new ways of dealing with natural hazards is communicated in this book, even though we have no illusions about radically changing the world overnight. We hope that at least our country will be moving in the right direction. Otherwise, we will be Paying the Price.

HOWARD KUNREUTHER

RICHARD ROTH, SR.

June 1998

HOWARD KUNREUTHER, co-editor, is the Cecilia Yen Koo Professor of Decision Sciences and Public Policy at the Wharton School, University of Pennsylvania, as well as Co-Director of the Wharton Risk Management and Decision Processes Center. He has a long-standing interest in improving how society manages technological and natural disasters, and has published extensively on the topic. Kunreuther is currently a member of the National Research Council Board on Natural Disasters and chairs the H. John Heinz III Center Panel on Risk, Vulnerability, and True Costs of Coastal Hazards. He is a recipient of the Elizur Wright Award for the publication that makes the most significant contribution to the literature of insurance, and is a distinguished Fellow of the Society for Risk Analysis.

RICHARD ROTH, SR., co-editor, is a retired insurance executive and property/casualty actuary. He is a Fellow of the Casualty Actuarial Society and a professional member of the American Meteorological Society, the American Geophysical Union, and the American Statistical Association. He has experience with

many aspects of natural hazards insurance and was Chairman of the Federal Insurance Administration's Write-Your-Own (WYO) Standards Committee for the National Flood Insurance Program. He is currently engaged as an actuarial consultant for the H. John Heinz III Center for Science, Economics, and the Environment for its Evaluation of Erosion Hazards project and is a member of the National Research Council's Board on Natural Disasters.

Jim Davis, California Division of Mines and Geology

Karen Gahagan, Institute for Business and Home Safety

Robert Klein, Georgia State University

Howard Kunreuther, University of Pennsylvania

Eugene Lecomte, Institute for Business and Home Safety

Charles Nyce, University of Hartford

Risa Palm, University of North Carolina

Edward Pasterick, Federal Emergency Management Agency

William Petak, University of Southern California

Richard Roth, Jr., California Department of Insurance

Craig Taylor, Natural Hazards Management

Eric VanMarcke, Princeton University

Paying the Price