Managing Catastrophe Risk: Why Do Homeowners, Insurers, and Banks Not Use Simple Measures to Mitigate the Risk from Hurricanes and Earthquakes?

Abstract

Property owners, insurers, and developers would all benefit from increased use of Risk Mitigation Measures (RMMs), which are investments made to structures that reduce expected losses from hurricanes, earthquakes, and other natural disasters. However, few property owners voluntarily invest in RMMs, few insurers offer incentives for policyholders (and few banks offer incentives to developers and builders) to employ these measures, and potential home buyers do not demand that developers and builders install RMMs. Thus insurance customers and taxpayers bear a larger portion of the cost of disaster losses. In a first-best world, we would advocate insurance and mortgage reform so that the key players in the housing market would have the incentive to encourage homeowners to mitigate. But the combination of individuals' lack of concern before a disaster and government coming to the rescue after the event puts us in a second- or third-best world. Thus, we favor policy interventions that save taxpayers money by regulating decisions between willing buyers and sellers.