[ MANAGING rISk ]
Weathering the
“We actually do fairly well with rescuing people afterwards. But we do a bad job of preparing for the disasters before they strike.”
STORM I
n the aftermath of a natural disaster, the focus is to help those in the heart of the storm rebuild their lives. As we’ve seen with Hurricane Katrina and most recently with Superstorm Sandy, providing that relief is often a slow and laborious process. It’s also a very expensive one. Damage estimates for Sandy are nearing $40 billion, and Katrina was more than double that. With the costs so high and the incidence seemingly more frequent, what are the obligations that individuals, insurance companies, and the government have for paying the bills? Research conducted by Tatyana Deryugina, assistant professor of finance, examines new solutions for financing disaster relief and for adequately preparing for disasters in the first place. Part of the problem is that so many people are underinsured for a natural disaster.
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“People can be very risk-averse,” Deryugina says, “but when it comes to taking out insurance against big risks such as natural disasters, they are reluctant to do so.” Many have an “it-won’t-happen-to-me” mentality even when they live in high-
risk areas such as California or the southeastern coast of the United States. Another issue, Deryugina says, is that people expect the government, through the Federal Emergency Management Agency (FEMA) and other safety net pro-
If you’re not willing to pay an extra amount each year to live on the coast, then maybe you shouldn’t be living there. Tatyana Deryugina
grams, to bail them out when disaster strikes. SPIRALING COSTS Over the last three decades, annual FEMA expenditures on disaster aid have risen substantially, from $732 million in the 1980s to $3.5 billion in the 1990s to $9.2 billion in the 2000s. These comparisons are all in 2009 dollars. “And this does not include spending in disaster areas through other social programs, such as unemployment insurance and Medicaid,” says Deryugina. Spending in those “safety net” areas rises substantially after a disaster and can even surpass FEMA expenditures. Part of the reason disaster aid has grown so dramatically is a population shift, she explains. “We’ve seen coastal populations grow disproportionately relative to populations further inland. There are more people living in danger-
ous areas, and these areas are also disproportionately wealthy. Of course, part of it can be coincidence, too. Certainly what we saw with Katrina was unprecedented.” Whatever the reason, the escalating costs of natural disasters are making plenty of people—particularly those in the government and in the insurance and reinsurance business—uneasy. “One reinsurance company estimated that relative to 2000, by 2050 we’re going to see a 750% increase in damages from natural disasters” (in real dollars, after adjusting for inflation), Deryugina says. “Insurance companies are worried about how to stay solvent through this.” In addition, she says, “The disaster process is pretty political. If you’re on the right committee, it’s easier for your state to get disaster funding, and you’ll get more of it. It’s been estimated that up to onehalf of all disaster aid is politically
motivated rather than driven by fundamentals of the disaster.” THROWING OUT A LIFELINE What can be done to reign in the costs that the government incurs? Deryugina suggests that one option is for residents in high-risk areas to pay FEMA premiums. “People living in those high-risk areas are being subsidized by people living in less risky areas, because we all pay the taxes that support FEMA,” she says. “You do want to have some sort of help for poor homeowners, but you could target that more directly than just making FEMA free to everybody. If you’re not willing to pay an extra amount each year to live on the coast, then maybe you shouldn’t be living there.” Deryugina hopes to do some modeling to see what the premiums would be, but believes they would be “fairly low” because dis-
asters rarely hit in the same place within a short time. Other solutions to deal with the rising costs of disasters include mandating that everyone pay for disaster insurance (this hasn’t gotten off the ground) and creating stricter building codes (this has some traction). Deryugina has researched the building code issue and is soon to publish a paper on her research. The American Society of Civil Engineers rates areas for wind speeds that buildings must be able to withstand. Some buildings might be within a 150-mph area, others within a 140-mph area, and so on. Obviously, the ability of a structure to withstand higher winds means less potential damage and, therefore, lower costs for repair and relief. “Not only do building codes help prevent damages, they help prevent government spending af-
terwards,” says Deryugina. “So this touches on the importance of mitigation. It’s not just about protecting the homeowners; it’s also about protecting the taxpayer. Our focus should be less on disaster aid, and more on disaster prevention. There’s research that shows for every $1 in mitigation spending, we could get as much as $15 in damage reductions. So that’s a huge benefit-to-cost ratio.” Prevention measures such as passing stricter building codes, building levees, reducing insurance premiums for homeowners who install hurricane shutters or take other measures to protect their houses, and encouraging insurance purchases could help in combating the rising costs of disasters, Deryugina says. “We actually do fairly well with rescuing people afterwards,” she observes. “But we do a bad job of preparing for the disasters before they strike.”
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Tom Hanlon
Perspectives SPRING 2013
THE SPIRALING COSTS FOR FINANCING DISASTER RELIEF
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