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Chapter 5: Insurance and Coping

to deny assistance to those affected, established the National Flood Insurance Program (NFIP) in 1968. The premia were set low to induce homeowners to buy the NFIP insurance, but very few people voluntarily purchased coverage (Kunreuther and Michel-Kerjan 2009). The federal government then required this coverage as a condition for federally insured mortgages, but the mandate was poorly enforced and many people canceled their policies, especially if there was no flood for several years, and others purchased insurance just after a flood (Michel-Kerjan and Kousky 2010). They examine more than five million insurance policies, the largest flood insurance sample ever studied, and find that of the one million residential NFIP flood insurance policies in place in Florida in 2000, a third were cancelled by 2002 and about two-thirds were cancelled by 2005. There was no effective mechanism to prevent or discourage more people from settling in the areas known to be hazardous: the NFIP is a federal program, while zoning and insurance regulation are state issues, and local politicians reflected the settlers’ desires. The number of policies nationwide managed by the NFIP increased from 2.5 million in 1992 to 5.6 million in 2007 and, in nominal terms, the property value covered rose from $237 billion to $1,100 billion during the same period. The NFIP’s other shortcomings were exposed after Hurricane Katrina flooded much of New Orleans in 2005. The NFIP covers floods, but private insurance covers wind damage. Many disputes arose over who should pay when damage from wind could not be easily separated from that by floods (Kunreuther and Michel-Kerjan 2009). Victims were given the runaround and payouts were delayed. In a background paper for this report, Kunreuther and Michel-Kerjan note how multihazard insurance can address insurer-insured disputes by having homeowners’ coverage move from the traditional one-year insurance contract to multiyear contracts (say 10 or 15 years) tied to the property (not the owner as is the case today). The premia would reflect insurers’ best estimate of the risk over that period and would assure policy holders of coverage. The possible denial of coverage was a major concern in hazardprone areas because insurers canceled policies following the 1992 and 2005 hurricane seasons. Following Hurricane Andrew, Florida passed a law in 1992 limiting the cancellation of policies by insurers to 5 percent a year at the state level and to 10 percent at the county level (Jametti and von Ungern-Sternberg 2009). Both insurers and home owners cancel policies for different reasons, and the premia are subject to political pressures. These major changes in government policy require appropriate regulatory authority and decisions (Kunreuther and Michel Kerjan 2008). Comprehensive, multihazard insurance will entail higher premia. Some policyholders may think they are being charged for coverage they do not need (a person in an earthquake area not prone to hurricanes and floods may only have quake insurance), but they would not be overcharged if premia reflect risk accurately. Whether premia accurately reflect risks becomes all the more important.

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Profile for World Bank Group Publications

Natural Hazards, UnNatural Disasters: The Economics of Effective Prevention  

Earthquakes, droughts, floods, and storms are natural hazards, but unnatural disasters are the deaths and damages that result from human act...

Natural Hazards, UnNatural Disasters: The Economics of Effective Prevention  

Earthquakes, droughts, floods, and storms are natural hazards, but unnatural disasters are the deaths and damages that result from human act...

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