Abstract
This chapter explores how insurance markets can be used to manage social exposure to catastrophic risks. Insurers set premiums to reflect underlying risk levels that they calculate using their best actuarial science. This process gives individuals private incentives prospectively to mitigate risks of loss. Private insurers, however, frequently exclude natural hazard losses from coverage, removing the private loss mitigation incentives from the market and leaving individuals without insurance against natural hazards, unless government-provided or – sponsored plans step in. These government programs amount to a species of public insurance against natural hazards. The chapter explores problems inherent in these public programs and finds that private insurance provides a viable alternative. Conventional explanations say that private insurers exclude natural disaster losses, and indeed are incapable of covering these risks, because of the difficulty in insuring highly correlated, high-dollar losses. However, I show as a matter of both theory and practice that these explanations do not fully explain private insurers’ behavior. Instead, I argue that insurers exclude natural disaster losses because of costly market contracting between insurers and policyholders. Information imbalances between policyholders and insurers and coordination failures among insurers lead to an equilibrium where natural hazard coverage is sacrificed for lower premiums. This analysis suggests that a regulatory response focusing on mitigating or compensating for contracting costs could reinvigorate private insurance’s role in managing risk and offer significant benefits. Throughout the chapter I draw from the United States flood insurance program, a 50-year project run by the federal government that has experienced representative degrees of successes and failures, to show the practical implications from this analysis.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Similar content being viewed by others
References
Abraham K (2010) Insurance law and regulation. Foundation Press, New York
Arrow KJ (1978) Risk allocation and information: some recent theoretical developments. Geneva Pap Risk Insur Theory 8:5–19
Avraham R (2012) The economics of insurance law – a primer. Conn J Insur Law 19:29–112
Boardman ME (2006) The allure of ambiguous boilerplate. Mich Law Rev 104:1105–1128
Eisner R, Strotz RH (1961) Flight insurance and the theory of choice. J Polit Econ 69:355–368
Faure M, Hartlief T (2006) The Netherlands. In: Faure M, Hartlief T (eds) Financial compensation for victims of catastrophes: a comparative legal approach. Springer, Berlin, pp 195–226
FEMA (2013) The NFIP’s specific rate guidelines. http://www.fema.gov/media-library-data/20130726-1920-25045-7258/fact_sheet_specific_rate_guidelines.pdf. Accessed 18 Aug 2014
Fugate C (2013) Statement of Craig Fugate, FEMA Administrator, before the committee on banking and urban affairs, subcommittee on economic policy. Implementation of the Biggert-Waters flood insurance reform act of 2012. http://www.fema.gov/media-library-data/bb350d766a3dd4a4f8ecec0ccc783957/9-18-3_IMPLEMENTATION+OF+THE+BIGGERT-WATERS+FLOOD+INSURANCE+REFORM+ACT+OF+2012.pdf. Accessed 19 Aug 2014
GAO (2014) GAO-14-127, Flood insurance: strategies for increasing private sector involvement. http://www.gao.gov/products/GAO-14-127. Accessed 21 Aug 2014
Hayden HR (1904) Hayden’s annual cyclopedia of insurance in the United States 1903–1904. Insurance Journal Company, Hartford
Huber M, Amodu T (2006) United Kingdom. In: Faure M, Hartlief T (eds) Financial compensation for victims of catastrophes: a comparative legal approach. Springer, Berlin, pp 261–301
Jerry RH, Richmond DR (2012) Understanding insurance law. LexisNexis, San Francisco
Johnson EJ et al (1993) Framing, probability distortions, and insurance decisions. J Risk Uncertainty 7:35–51
Korobkin R (2003) Bounded rationality, standard form contracts, and unconscionability. Univ Chic Law Rev 70:1203–1295
Kunreuther H (1996) Mitigating disaster losses through insurance. J Risk Uncertainty 12:171–187
Manes A (1938) Insurance: facts and problems. Harper and Brothers, New York
Molk P (2014) The puzzling lack of cooperatives. Tulane Law Rev 88:899–958
Molk P, Rowell A (2016) Reregulation and the regulatory timeline. Iowa Law Rev 101 (in press)
Munich Re (2014) Loss events worldwide 1980–2013. http://www.munichreamerica.com/site/mram/get/documents_E-205039058/mram/assetpool.mr_america/PDFs/5_Press_News/Press/natcat012014/1980_2013_events_and_losses.pdf. Accessed 17 Aug 2014
NAIC (2007) Homeowners insurance survey. http://www.naic.org/documents/newsroom_homeowners_insurance_summary.pdf. Accessed 20 Aug 2014
Priest GL (1996) The government, the market, and the problem of catastrophic loss. J Risk Uncertainty 12:219–237
Priest GL (2003) Government insurance versus market insurance. Geneva Pap Risk Insur 28:71–80
Schwarcz D (2011) Reevaluating standardized insurance policies. Univ Chic Law Rev 78:1263–1348
State Farm (2014) State Farm companies. https://www.statefarm.com/about-us/company-overview/company-profile/state-farm-companies. Accessed 19 Aug 2014
Stempel JW (2013) Rediscovering the Sawyer solution: bundling risk for protection and profit. Rutgers J Law Public Policy 11:171–289
Van den Bergh R (2006) Compulsory catastrophe extension of first party property insurance from a competition policy perspective. In: Faure M, Hartlief T (eds) Financial compensation for victims of catastrophes: a comparative legal approach. Springer, Berlin, pp 361–387
Wuebbles DJ (2015) Setting the stage for risk management: severe weather under a changing climate. In: Gardoni P, Murphy C, Rowell A (eds) Risk analysis of natural hazards. Springer, Cham
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2016 Springer International Publishing Switzerland
About this chapter
Cite this chapter
Molk, P. (2016). Private Versus Public Insurance for Natural Hazards: Individual Behavior’s Role in Loss Mitigation. In: Gardoni, P., Murphy, C., Rowell, A. (eds) Risk Analysis of Natural Hazards. Risk, Governance and Society, vol 19. Springer, Cham. https://doi.org/10.1007/978-3-319-22126-7_15
Download citation
DOI: https://doi.org/10.1007/978-3-319-22126-7_15
Publisher Name: Springer, Cham
Print ISBN: 978-3-319-22125-0
Online ISBN: 978-3-319-22126-7
eBook Packages: Economics and FinanceEconomics and Finance (R0)