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The year 2018 was marked by extraordinary natural disasters in the United States and around the world. California bore witness to devastating mudslides in Montecito and massive wildfires across the state, including the deadly Camp Fire in Northern California that scorched more than 150,000 acres. In the South, Hurricane Florence deluged the Carolinas while Hurricane Michael landed in the Florida Panhandle as the third-strongest storm ever to come ashore in the U.S.
While the loss of life from natural disasters is immeasurable, the destruction of property and infrastructure can cost hundreds of billions of dollars. Scientists believe the damage will only get worse as climate change creates more frequent and intense weather events. So, how should governments, communities and individuals prepare in the new year?
As part of a series titled “2019: A Look Ahead,” the Knowledge@Wharton radio show on Sirius XM invited three experts to talk about the topic: Howard Kunreuther, professor of operations, information and decisions and co-director of the Risk Management and Decision Processes Center at Wharton; Robert Hartwig, clinical associate professor of finance and director of the Risk and Uncertainty Management Center at the University of South Carolina’s Darla Moore School of Business; and J. Keith Gilless, professor and dean emeritus of the College of Natural Resources at the University of California-Berkeley.
Following are five key points from their conversation.
Preparation Should Start Now
As natural disasters increase in their frequency and severity, the efforts to recover from them will take longer and cost more money. That’s why everyone needs to prepare now, the three experts said.
“This is a global problem, and we’re going to be facing it in a way that is really unprecedented with respect to the issues of climate change and sea level rise,” Kunreuther noted. “We have a real challenge in terms of adapting to these things now — taking steps where people generally don’t want to take steps for a lot of good reasons” including the associated costs.
Hartwig, who lives in South Carolina and has studied the financial effects of coastal storms, pointed out that economies in the Southeast are accustomed to hurricanes and generally bounce back quickly. But recovery isn’t a given, especially if the damage gets worse.
“The major concern is that when they bounce back, do they bounce back in a smart way?” he said. “In other words, in a way that makes them more resilient in the face of the absolute certainty that events like these will be occurring in the future, if not with increased frequency, then potentially with increased severity.”
Cooperation between governments, the insurance industry and individual property owners is the best path forward, the experts said. Governments need to pass and enforce legislation on a number of fronts, from better building codes to evacuation plans and requiring insurance. The insurance industry needs to respond by providing wide access to the right kinds of products and services. And property owners need to secure adequate insurance, both in terms of type and coverage.
Kunreuther cited the Camp Fire in California, which killed 85 people and torched 13,000 homes, as an example of why wildfire risk mitigation is so important. Wharton’s Risk Management and Decision Processes Center is researching the topic now. “It’s at the center of our attention with respect to how one can actually tie the mitigation aspect to the recovery aspect and who’s going to pay for this,” he said. “There’s an enormous problem with respect to rebuilding and recovery in places like where the Camp Fire hit. So, we do have a challenge, and we need to have public-private partnerships to deal with that.”
All Politics Is Local
The first step in risk mitigation is defining areas of risk, but that activity is inherently political, according to Gilless.
He recalled how the state of California once relied on local governments to produce the maps that delineated high-hazard locations for wildfires. Those maps had lines of demarcation that closely followed county boundaries, indicating that politics – not science – played a big role.
“You could go from a very high fire hazard, step over an imaginary line, which was a county line, and suddenly be in a much lower hazard [area],” Gilless said. “We had to solve that by moving that mapping function up a level.”
Hartwig joked that hazard risk maps can sometimes resemble gerrymandered congressional districts when science takes a back seat to politics. “Local politicians will step in and object that their community has been designated, for instance, a very high-hazard zone [for flooding] even though it has routinely been found to be underwater, because it does increase the cost of development.”
According to Hartwig, California and other states prone to natural disasters should make sure they have resilient building codes and zoning ordinances while not repeating some of the “mistakes of the past.” He referred specifically to how Florida reacted to past hurricanes by meddling in the market.
“The state’s knee-jerk reaction has been [to tell insurers], ‘We don’t care how much you lost over the past couple of years, we’re going to freeze your rates.’ Economics 101 suggests that’s ultimately going to result in a reduction of capacity for consumers, and that’s exactly what happened,” he said. “The state itself wounded up having to become the largest home insurer in the state of Florida and one of the largest in the country.”
“This is a global problem, and we’re going to be facing it in a way that is really unprecedented with respect to the issues of climate change.” –Howard Kunreuther
In California, the state is the “insurer of last resort,” which is not a good position for any state to be in, Gilless said. “You’d rather have the markets functioning well here.” That means having an insurance industry with a “strong feedback loop” between rate-setting and community/individual action, and some guarantee that property owners can have access to insurance without the state stepping in.
“It means we, as Californians, also have to treat the underlying problems and not the symptoms,” Gilless noted, emphasizing that safety should be a priority. “The politics of whether or not we invest in community planning versus hiring more firefighters and more air resources are playing out in the state right now.”
It is difficult to strike a balance between the state and local authorities on issues such as planning and zoning, which are fundamentally local, he added. But perhaps states should provide greater guidance on such topics. “That’s not going to be easy. I think anyone in the business world understands that the balance of power on many development issues is held quite locally.”
Some Communities Suffer More Than Others
One of the biggest challenges in dealing with risk is the affordability of insurance for low-income residents and the financial recovery for communities without wealth. Disaster insurance is expensive and considered a luxury by many residents, especially renters.
For example, less than 10% of people in California have earthquake insurance, which is provided by the California Earthquake Authority, a public-sector agency, Kunreuther said. If another major earthquake happens, low-income families would be hardest hit financially, he added. “You’re going to be faced with an amazingly challenging problem for many of these residents in terms of their recovery process if they have buildings destroyed.”
Complicating matters is the fact that homeowners aren’t legally required to carry insurance once they have paid off their mortgages and own the property outright.
“You also have state regulators that would have to let the insurers charge premiums that reflect risk and at the same time try deal with the affordability issue in other ways, possibly through public-private partnership with the state and the federal government helping low-income people in some fashion,” Kunreuther said. “But without the regulators actually letting go on that, it’s really a nonstarter because no insurer is going to want to add earthquake insurance onto a policy and be forced to charge a very low premium in areas where there really is a severe risk.”
Gilless highlighted research that shows a perplexing discrepancy in the recovery of low-income versus middle-income areas. It is understandable that poor communities with inadequate infrastructure would suffer the most, but what is surprising is that many middle-income regions also struggle in the wake of a disaster.
“I think anyone in the business world understands that the balance of power on many development issues is held quite locally.” –J. Keith Gilless
“We did one case study in Costa Rica as a good example — their infrastructure is far more valuable, but the institutions to deal with the impact of natural hazards damaging their infrastructure haven’t evolved at the pace that they’ve increased their stock of economic capital in the form of roads, bridges, businesses,” he said. “There is perhaps this area of vulnerability in the middle-income countries that is not apparent when you look at the devastation in a country with very poor infrastructure immediately after the incident.”
Destruction Is Long, but Memory Is Short
As previously noted, many private property owners simply go without insurance because they consider it an unnecessary expense. They would rather spend the money elsewhere and take the long odds that something terrible will happen exactly where they live.
They also tend to forget about damage from the last natural disaster as the event grows more distant, the professors said.
Kunreuther partly attributes the low penetration of earthquake insurance in California to the fact that the state’s last major temblor was the Northridge quake in 1994. “Most people feel that they don’t need [insurance] or don’t want it, and of course they forget that they’ve had an earthquake because there hasn’t been a serious one since [then].”
Hartwig agreed, saying rates of earthquake insurance coverage in California increased to about 30% in the years following the Northridge quake, then dropped back down as people put the event behind them.
Enforcement is also a problem, he noted. Even in places where flood insurance is required with the purchase of a mortgage, coverage tends to lapse as mortgages change hands.
Is Comprehensive Insurance the Answer?
The experts argued for a multi-pronged approach to risk mitigation that includes public-private partnerships, better regulation and enforcement, and serious preparation by private citizens.
Requiring comprehensive property insurance that would cover a range of natural disasters could be more effective in mitigating risk, Kunreuther suggested. The insurance industry is exploring the idea. “It’s a nice idea in theory,” he said. “But one could move in that direction and banks would then have to require it.”