The Role of Insurance in Reducing Losses from Extreme Events: The Need for Public-Private Partnerships

Abstract

This paper describes the challenges consumers, insurers and insurance regulators face in dealing with insurance for low-probability high-consequence events. Given their limited experience with catastrophes, there is a tendency for all three parties to engage in short-term intuitive thinking rather than long-term deliberative thinking when making insurance-related decisions. Public-private partnerships can encourage investment in protective measures prior to a disaster, deal with affordability problems and provide coverage for catastrophic risks. Insurance premiums based on risk provide signals to residents and business as to the hazards they face and enable insurers to lower premiums for properties where steps have been taken to reduce their risk. To address issues of equity and fairness, homeowners who cannot afford insurance could be given vouchers tied to loans for investing in loss reduction measures. The National Flood Insurance Program provides an opportunity to implement a public-private partnership that could eventually be extended to other extreme events.

Keywords: natural disasters, flood insurance, earthquake insurance, disaster insurance, terrorism, public-private partnerships

JEL Classification: D01, D03, D81, G22, Q54