Crises as Catalyst in Public Health Seminar Series September 13, 2010

1. Learning from Catastrophes: Strategies for Reaction and Response in Public HealthHoward C. Kunreuther kunreuther@wharton.upenn.eduRisk Management and Decision Processes CenterThe Wharton School, University of Pennsylvaniahttp://opim.wharton.upenn.edu/risk Crises as Catalyst in Public Health Seminar Series September 13, 2010

2. Summary of Key Points Individuals focus on short-term horizons Want immediate return from their preventive measures Often regard potential disasters as below their threshold of concern Impact of this behavior Failure to take protective measures prior to a disaster Cancel insurance if one doesn’t make a claim for a few years Proposed strategy Well-enforced long-term contracts Short-term economic incentives to deal with myopia

3. Outline of Talk Part 1: Linking Risk Assessment and Risk Perception with Risk Management: A Conceptual Framework for Studying Risk Risk Assessment and Vulnerability Analysis Risk Perception and Choice Risk Management Strategies Part 2: Managing Catastrophic Risks in an Uncertain World 1. A New Era of Catastrophes 2. Guiding Principles for Developing Risk Management Strategies 3. Benefits of Protective Measures 4. A New Proposal: Multi-Year Flood Insurance 5. Encouraging Protection: An Example 6. Future Research: Multi-Year Health Insurance with Short-Term Incentives 7. Summary

4. A Conceptual Framework for Studying Risk Risk Assessment & Vulnerability Analysis Risk Perception and Choice Public Perceptions Expert/Layperson Differences Risk Communication Modeling of Risks Statistical Data Building Scenarios Risk Management Strategies Public Private Partnerships

5. A Conceptual Framework for Studying Risk Risk Management Strategies: Public Private Partnerships Information Provision Incentives Regulation Standards Compensation Insurance Liability Evaluation of Strategies Impact on Society Impact on Interested Parties

6. 1. Risk Assessment and Vulnerability Analysis Risk Assessment • Encompasses estimates of both the chances of a specific set of events occurring and their potential consequences • Experts differ in their estimates of the risk • Find your favorite expert to support your position Vulnerability Analysis • Characterize forms of physical, social, political, economic, cultural, and psychological harms to which individuals and modern societies are susceptible • Millions of dollars have already been spent to reduce our vulnerability Constructing Scenarios • What are the probabilities of specific events? • What are the potential consequences?

7. Risk Assessment Questions to Ponder • What are the chances that New Orleans will have a Category 3 or higher hurricane in the next 5 years, and what would be the resulting damage and health impacts? • What are the chances that there will be another severe oil spill in the U.S. in the next 5 years and what would be the health and environmental impacts? • What are the chances of a swine flu pandemic in 2011 and how serious would the consequences be? • What are the chances that there will be a smallpox epidemic in the United States in the next five years, and how many people would be affected?

8. Uncertainty in Probability Uncertainty in Loss Probability p(L) that losses will exceed L 95% Mean 5% Loss, L (in dollars) Using Exceedance Probability Curves to Depict Risk

9. Risk Assessment and Vulnerability AnalysisOpen Issues and Questions • How accurately can experts estimate the likelihood and consequences of damage, injuries and fatalities from disasters of different magnitudes and intensities? • Can one characterize the types of uncertainties that currently exist in assessing risk and suggest ways to improve these estimates in the future? • What are the expected costs and benefits of undertaking specific risk-reducing measures in disaster-prone areas and can one rank them on the basis of cost effectiveness? • What are the interdependenciesin the system (e.g. infrastructure damage affecting supply of electricity, water, telephone/telecommunications, and other services to residences and businesses) and what are their impacts on indirect damage, health and environment?

10. 2. Risk Perception and ChoiceBasic Concepts • Individuals exhibit systematic biases in processing information and making choices • Estimating likelihood of event is influenced by salience • “It cannot happen to me” before a crisis or disaster occurs • “It will happen to me” immediately after a crisis or disaster • “I don’t have to worry” a few months after a crisis or disaster • Individuals have difficulties learning due to biases and information processing limitations

11. Explain this behavior: • I bought my first set of battery cables only after my car wouldn’t start and I had to be towed. The towing charge was twice as much as the cost of the battery cables. • Most homeowners in California purchase earthquake insurance only after they experienced a quake. When asked whether the probability of a future event was more likely than before the disaster most people responded “Less likely.” • Until seat belt laws were instituted in the United States, most drivers refused to wear them. When asked why they did not, a typical response was, “I won’t have an accident.” This response is consistent with the well-documented finding that 90% percent of all drivers feel they are better than the average driver.

12. Stigmatization and Social Amplification of Risk The Alar Case • No scientific evidence that Alar was carcinogenic • Were based upon animal studies that were considered suspect because the doses used had been so large as to have been acutely toxic. • No evidence from epidemiological studies showing Alar to be a human carcinogen. • The reaction by the public to Alar illustrates social amplification of risk • Media amplified the risk and effectively stigmatized the product • Millions of consumers stopped buying apples and apple products after CBS news story on “60 Minutes” stated Alar could cause cancer • Convincing my wife that children from birth to 3 could drink apple juice with Alar

13. Risk Perception and ChoiceOpen Issues and Questions • What role do perceived likelihoods and resulting consequencesplay in how people view a particular risk that they may face, such as a severe hurricane or a flu pandemic? • How important are emotional factorssuch as fear, dread and anxiety in how people perceive these risks and learn over time? • What role do social networks and social normsplay in influencing risk perception, choice, and learning with respect to low probability events? • How can one best communicate informationto those at risk so they are aware of what actions they can take prior to and after a crisis or disaster? • What is the role of past experience and the mediain influencing risk perception and choice?

14. 3. Risk Management Strategies Basic Concepts Policy options for reducing losses and aiding recovery process • Economic incentives • Insurance • Well-enforced regulations and standards (e.g., building codes) • Assistance following a disaster or crisis Relevant roles of public and private sectors in implementing hazard management strategy Criteria for evaluating alternative strategies • Efficiency -- allocating resources to maximize social welfare • Equity -- concern with fairness and distribution of resources

15. Risk Management Strategies Open Issues and Questions • What type of economic incentiveswould encourage individuals to mitigate the risks of a disaster and purchase insurance prior to a disaster? • How does the prospect of federal aidto victims affect protective decisions by individuals prior to a disaster? • What are the appropriate roles of standards and regulationsin reducing losses from large scale disasters and the impact of the event following the disaster? • What types of financial backstopsshould be provided by the public sector at the state and federal levels for dealing with catastrophic losses following future disasters? • How can one link different policy toolssuch as information provision, economic incentives, insurance, third party inspections, regulations and standards to achieve the desired objectives of a hazard management strategy?

16. Outline of Talk Part 1: Linking Risk Assessment and Risk Perception with Risk Management: A Conceptual Framework for Studying Risk Risk Assessment and Vulnerability Analysis Risk Perception and Choice Risk Management Strategies Part 2: Managing Catastrophic Risks in an Uncertain World 1. Cause for Concern: A New Era of Catastrophes 2. Guiding Principles for Developing Risk Management Strategies 3. Benefits of Protective Measures 4. A New Proposal: Multi-Year Flood Insurance 5. Encouraging Protection: An Example 6. Future Research: Multi-Year Health Insurance with Short-Term Incentives 7. Summary

17. 1. Cause for Concern: A New Era of Catastrophes • A radical change in the scale and rhythm of catastrophes • Natural disasters have caused large numbers of fatalities and destruction in recent years • Cyclone Nargis (Myanmar, May 2008) : 140,000 fatalities • Sichuan Earthquake (May 2008) : 70,000 fatalities and 5 million residents were homeless • Hurricane Ivan (Grenada, September 2004): $889 million in damage (365% of GNP) • Victims complain about receiving substantially less than the actual costs to repair or rebuild their damaged structures • Public sector and international organizations • (e.g., World Bank) are committed to providing • financial assistance to aid the victims of disasters

18. Worldwide Evolution of Catastrophe Insured Losses, 1970-2008 (Property and business interruption (BI); in U.S.$ billon indexed to 2007, except 2008 which is current) Sources: Kunreuther and Michel-Kerjan, At War with the Weather (2009) - data from Swiss Re and Insurance Information Institute

19. The 25 Most Costly Catastrophe Insurance Losses, 1970-2008 (17 here in the U.S., 12 of these since 2001) * * * * * * * * * * * *

20. Higher degree of urbanization Huge increase in the value at risk Population of Florida 2.8 million inhabitants in 1950 -- 6.8 million in 1970 -- 13 million in 1990 19.3 million population in 2010 (590% increase since 1950) Cost of Hurricane Andrew in 2004 would have been $120bn Weather patterns Changes in climate conditions and/or return to a high hurricane cycle? More intense weather-related events coupled with increased value at risk will cost more, much more. Will Hurricane Nicole, Otto or Paulamake landfall in the U.S. in 2010? What’s Happening? The Question of Attribution 20

21. Insured Coastal Exposure as a Percentage of Statewide Insured Exposure as of December 2007 (Residential and Commercial Properties) Source: Data from AIR Worldwide Corporation

22. Total Value of Insured Coastal Exposure as of December 2007 (in $ billion; Residential and Commercial Properties) Source: Data from AIR Worldwide Corporation

23. AT WAR WITH THE WEATHER July 2009 - MIT Press A better understanding of how individuals decide whether or not to protect themselves against natural disasters. A set of guiding principles for using insurance to deal more effectively with these events. Key lessons from the financial management of natural disasters to be applied to other global risks such as pandemics, financial crises and terrorism. Ideas for the private sector, and sustainable public policy solutions to protect trillions of dollars of assets and the residents at risk in hazard-prone regions.

25. 2. Guiding Principles for Developing Risk Management Strategies Principle 1: Premiums reflecting risk Insurance premiums should be based on risk in order to provide signals to individuals as to the hazards they face and to encourage them to engage in cost-effective adaptation measures to reduce their vulnerability to catastrophes. Risk-based premiums should also reflect the cost of capital insurers need to integrate into their pricing to assure adequate return to their investors. Principle 2: Dealing with equity and affordability issues Any special treatment given to homeowners currently residing in hazard-prone areas (e.g., low-income uninsured or inadequately insured homeowners) should come from general public funding and not through insurance premium subsidies.

26. Insurance VouchersExisting Programs as Models Food Stamp Program Mission: Vouchers to purchase food based on annual income and family size Low Income Home Energy Assistance Program Mission: Assist low income households in meeting immediate energy needs Universal Service Fund Mission: Provide discounts to low-income individuals in rural areas so rates for telecommunications services are comparable to urban areas 26

27. Insurance VouchersWho should subsidize low income residents? General taxpayer –Everyone in society is responsible State government– Source of funding would come from state taxes Insurance policyholders – All homeowners with insurance Residents in coastal areas – Those in hurricane-prone areas 27

28. 3. Benefits of Protective Measures On a 500-Year Event $160 billion loss $82 billion saving with Adaptation measures in place

29. Why Individuals Do Not Invest in Cost-Effective Protective Measures Short Time Horizons (Quick return on investment) High Short-Term Discount Rates (Hyperbolic discounting) Misestimating Probability (“It will not happen to me”) Liquidity and Upfront Costs (“We live from payday to payday”) Truncated Loss Distribution (Only responsible for small portion of loss due to disaster relief) May Move in 2 or 3 Years (Can’t recover costs of adaptation) 29

30. 4. A New Proposal: Multi-Year Flood Insurance Proposed strategy Multi-year flood insurance contracts through the National Flood Insurance Program (NFIP) Multi-year home improvement loans for mitigating one’s property Insurance and loans are tied to the property, not to the individual

31. Multi-Year Flood Insurance Provides Stability to Homeowners Rates would reflect risk (Principle 1) (FEMA needs to design better maps) Insurance Vouchers for those needing special treatment (Principle 2) (Only for those currently residing in flood-prone areas) Homeowners would have knowledge that they are protected against water damage from floods and hurricanes

32. 5. Encouraging Protection: An Example • Characteristic of Protective Measures Upfront cost/Multi-Year benefits • Cost of Mitigation – $1,500 to strengthen roof of house • Nature of Disaster • 1/100 chance of disaster • Reduction in loss ($27,500) • Expected Annual Benefits: $275 (1/100 * $27,500) • Annual Discount rate of 10% 32

33. Expected Benefit-Cost Analysis of Mitigation (Annual Discount Rate 10%) Upfront cost of mitigation Expected benefits over time

34. Rationale for Multi-Year Flood Insurance Encouraging Mitigation with Multi-Year Loans Illustrative Example Cost of partial roof mitigation: $1,500 Expected annual benefit of partial roof mitigation: $275 (1/100 * $27,500) Annual payments from 20 year $1,500 loan at 10% annual interest rate: $145 Reduction in annual insurance payment: $275 Reduction in annual payments due to mitigation: $275-$145= $130

35. Linking Multi-Year Home Improvement Loans with Multi-Year Flood Insurance Everyone is a Winner: Homeowner: Lower total annual payments Insurer: Reduction in catastrophe losses and lower reinsurance costs Financial institution: More secure investment due to lower losses from disaster General taxpayer: Less disaster assistance 35

36. 6. Future Research: Multi-Year Health Insurance with Short-Term Incentives for Better Health(joint project with Mark Pauly and Kevin Volpp) Question: How can we encourage individuals to adopt better health habits? Findings: (Volpp et al. 2008; Volpp et al. 2009) • Economic incentives induce people to stop smoking and induce obese individuals lose weight • When incentives are removed, some people resume bad habits Proposal: Multi-year insurance with premiums reflecting risk, and health insurance vouchers for those requiring special treatment • Premium reductions if you adopt better health habits • Premium increases if you don’t maintain better health habits

37. Example: Encouraging Weight Loss in Obese Individuals Current Status of Individual A Weight 250 lbs; Health Insurance Premium $1,000 Economic Incentive System for Individual A Lose 20 pounds 2011; Premium lowered to $800 Maintain weight in 2012; Premium remains at $800 Lose 5 pounds in 2012; Premium lowered to $750 Gain 5 pounds in 2012; Premium raised to $850 Note: Health insurance encourages better habits in much the same way that property insurance would encourage investing in cost-effective protection

38. 7. Summary The Facts: Totally new era of “large-scale risks”; huge and still growing concentration of value in high-risk areas; indication of more devastating disasters in the future with property and environment damage and health impacts The Reality: Individuals are myopic and misperceive risks, so they do not adopt cost-effective protective measures. Research and policy questions: Is multi-year insurance coupled with short-term incentives a way to encourage adoption of protective measures to reduce future damage and health risks? What are the challenges and opportunities of developing specific proposals so they have a chance of being implemented?