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4 Insurance and Real Estate Before Hurricane Hugo hit South Carolina in 1989, the United States had not experienced a single disaster that cost the insurance industry more than $1 bil - lion, said Howard Kunreuther, professor of decision sciences and business and public policy at the University of Pennsylvania’s Wharton School of Business, who moderated the first panel of the workshop. Since then, as more and more development has occurred in hazard-prone areas, the cost of natural disasters has gone up “exponentially,” with losses for 2000–2010 exceeding $800 billion (Kunreuther and Michel-Kerjan, 2009). Despite the increased risk, many individuals, homeowners, and businesses are failing to protect themselves against hazards, even though such protection could be very cost effective. Most people do not buy flood insurance, and when they do buy it, they often cancel it several years later. The members of the panel on insurance and real estate, Julie Rochman, Eric Nelson, and Ommeed Sathe (Appendixes B and C), were asked to consider four questions in the preparation of their remarks: 1. What are meaningful incentives to encourage property owners to adopt effective mitigation measures in existing homes? 2. What role can the private and public sectors play in assuring that home- owners, businesses, and communities are preparing for and recovering from natural disasters in the future? How can progress toward that goal be measured? 3. Does economic development in hazard-prone areas (coastal zone, floodplain, earthquake zone, et cetera) necessarily conflict with the resilience of those communities? What are some best practices (or examples) of resilient development? 43

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44 INCREASING NATIONAL RESILIENCE TO HAZARDS AND DISASTERS 4. What are the lessons that can be learned from the recovery process fol - lowing Hurricane Katrina that can provide guidance in designing implementable strategies for making communities more resilient? RESEARCH ON RESILIENCE: JULIE ROCHMAN Just as tests of automobile safety are done so that people can make better choices about how to protect themselves and their families, testing of structures is under way. At a facility in South Carolina, the Institute for Business and Home Safety (IBHS) can simulate category 1, 2, and 3 hurricanes; wildfires; hail storms; and other natural disasters to measure the durability of buildings. “We don’t believe any building can be considered high performance if durability is not a piece of the performance measure,” said Julie Rochman, president and chief executive officer of IBHS. Communities exist in structures—not just in homes but in businesses and public buildings as well. Thus, structural durability is essential to prevent a cas - cading chain of failure that can destroy any community, large or small. Resilient buildings are also better for the environment, because they do not have to be buried in landfills if they are destroyed by a natural disaster. Hurricane Katrina affected 14 states and easily could have affected 20. In that respect, the Gulf Coast is a warning belt for much of the rest of the United States, since wind- and water-related damage can occur in many places other than the coast, Rochman said. Those who care about the built environment also care about the bayous, the wetlands, and the natural barriers near coasts, since these pieces of the natural environment scrub energy off storms before they hit structures. In this way, the natural environment and the built environment are intertwined. Financial incentives are often necessary to help people adopt effective miti- gation measures, Rochman said. If people have to pay for mitigation without any incentives, they will tend not to do it. These incentives should extend to everyone with a stake in structures, such as mortgage lenders, tax appraisers, and realtors. People need to learn to “value resiliency more than they do granite countertops and stainless steel appliances.” Building codes are compulsory standards, in contrast to voluntary incentives. However, most compulsory standards are written by a committee, which means that they inevitably carry “a tinge of politics.” Engineering and building science need to inform building codes for standards to be effective. Also, a building code is a minimum standard, Rochman emphasized. In con- trast, fortified programs, whether for new or existing buildings, call for building codes to be augmented by voluntary construction standards. IBHS, for example, provides a relatively inexpensive set of things that homeowners can do to improve the durability of their homes. Many of these address the roof. Once a roof cover is compromised, “all sorts of bad things can happen to the structure.” The measures

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45 INSURANCE AND REAL ESTATE also concentrate on openings—windows, doors, and other openings that can liter- ally blow a home apart. Finally, the provisions look at the load path of a structure to ensure that components are connected adequately. Building to fortified codes in the Gulf Coast states would save anywhere from one-third to two-thirds of losses, according to Rochman. Given that the value of property vulnerable to hurricanes from Texas to Maine is an estimated $9 trillion, retrofitting is essential. Consumers and policy makers need to understand that codes do not necessarily provide them with a superior level of protection in their homes and businesses. In places where building codes are lax or nonexistent, people might think that they are buying a structure that is safe. An irony is that homes are often purchased using 30-year mortgages, but the structures being built can stand for just a few years if a storm strikes. People in the United States tend to believe that they should live the way they want and where they want, said Rochman. When baby boomers move from Ohio to the Gulf Coast, they often put up wood frame houses like those in Ohio. But traditional houses in areas susceptible to hurri - canes tend to be sturdier, just as homes in New England tend to lack north-facing windows and have pitched roofs. People should “build for where they live,” she said. The design community needs to consider durability as part of a “vernacular architecture.” Many people believe their houses are resilient when in fact they are not. “We get calls from people all the time who say, ‘Can you designate my house as fortified. My engineer told me I can withstand a category 5 in this thing. It’s like a bunker.’ We’ll go look at it and it’s built out of wonderful reinforced masonry with great anchored windows, but the roof isn’t held on at all. There’s no strap- ping tying the roof to the walls. We’ll tell people and they’re furious because they spent [so much] to make a resilient home.” Communities, government, and the design and construction industries have not made durability a priority at every step of the process—in design, construction, rehabilitation, and renovation. Yet costs for everyone are substantially lower in disasters if resilience is built into structures from the beginning. Rochman observed that one of the reasons for studying the durability of structures is to generate compelling videos to disseminate to consumers. IBHS has a video on YouTube that compares two identical homes subjected to a cat- egory 3 hurricane, one of which has several upgrades that cost a few thousand collars. “It’s startling, and anybody can understand it.” The real estate industry could benefit from several practices common in the automobile industry. New cars have a sticker in their windows that provide the mileage, crash safety rating, cargo space in the trunk, and so on. A listing for a home says how many bedrooms and bathrooms it has, whether it has stainless steel appliances, and so on, but contains essentially no information about the structural integrity of that house. “It will not tell you anything about the roof. It won’t tell you if it was built to code or if it’s been added onto by Uncle Bob

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46 INCREASING NATIONAL RESILIENCE TO HAZARDS AND DISASTERS instead of a licensed contractor.” Appraisers and others who value mitigation need the education and data to provide that information to consumers in a digestible form. However, ratings are somewhat different for houses than cars, Rochman observed. “If you buy a Taurus in Seattle, [it is the same as if] you buy a Taurus in Miami,” she said. However, most people don’t remodel a Taurus by “cutting it in half and putting a bathroom in it.” Ratings will also expire as people do things to maintain or renovate their property that render the initial rating meaningless. Partnerships between the public and private sectors are essential to make a community more resilient. No one entity, whether the insurance industry or the government, can fund everything that needs to be done. Everyone who has a stake in the built environment has to participate. Development in hazard-prone areas need not be a barrier to mitigation. “The city of New Orleans, I hope, is always going to be here,” Rochman said. “There are economic imperatives that create coastal development. You can’t just say, ‘Move the cities.’ We have to deal with it, and there are ways that we can do that by hardening structures against nature.” The formula for success is to implement workable and affordable retrofits for existing structures and design standards for new structures based on good science. “We can do better. We can break the cycle of destruction.” INSURANCE AVAILABILITY AND AFFORDABILITY: ERIC NELSON Many communities are facing a crisis of insurance availability and afford- ability, said Eric Nelson, vice president for personal insurance operations at Travelers Insurance. Forging a partnership with business is the only way to resolve this issue. Insurance companies spread risks over people or over time. As a result, when risks go up, insurance prices go up. During the 1990s, more than $1 tril - lion of condominiums were built on the Miami coast. “People want to enjoy the sun. Unfortunately, Miami is not the best spot when you’re thinking about hurricane risk.” Travelers Insurance has partnered with organizations like IBHS to study ways of minimizing costs to consumers. One thing it has found is that the levels of damage to homes within a neighborhood or just a short distance away from each other can be very different. In one study, for example, homes built in accor- dance with the most recent building codes suffered about 35 percent less damage than homes not meeting those standards. “That translates into 35 percent lower insurance costs over time,” said Nelson. The best aspects of building codes in one jurisdiction need to be adopted in others. The insurance industry would prefer federal building codes but under- stands that such a goal is not realistic today. But building codes are developed and enforced very differently in different states.

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47 INSURANCE AND REAL ESTATE After Katrina, Louisiana “did a great job” and adopted stronger building codes. Such codes would be beneficial in other states, but costs are involved in upgrading and enforcing building codes. In that regard, meaningful credits for mitigation have the potential to improve resilience. In Alabama, for example, Travelers Insurance offers a 35 percent discount for mitigation using fortified building standards. “We’re trying to see how many consumers are going to take advantage of that program.” Circumstances for insurance companies can change drastically over time. For example, before Hurricane Katrina, insurance companies were required to have enough capital to cover one 100-year event. After Katrina, they had to have enough to cover two 100-year events. “That is a dramatic change,” said Nelson, but such regulatory changes can be important if they are necessary for companies to be there after a storm. Nelson asked whether homeowners should receive mitigation credits in the same way that they can receive credits for putting new windows in their homes. Nelson specifically cited the South Carolina Safe Home Program as an example for other states to follow on mitigation. Better disclosure and dissemination of information also can have a major influence on consumer decisions. As an exam- ple, he cited a smartphone application that allows people to locate their homes on flood maps. Consumers, as opposed to researchers or companies, can drive improvements if they receive the necessary information and education. Finally, some people cannot afford the price of mitigation. Though wealthy people may live right on the beach, the people living a few blocks inland can have much more modest means, which translates to a gap in the ability to afford miti - gation against potential disasters for homeowners. Nelson said that regulations should reflect those differences. Affordability vouchers may be a way to address the affordability gap for mitigation. All states need a healthy and vibrant insurance market, Nelson said. Com - munities and states also need to think about where and why structures are built and enhance durability before a loss occurs. And consumers need to know about the perils they face through the provision of information that they can understand. REEXAMINING RISK: OMMEED SATHE It now costs more to build a new home in New Orleans than most buyers can afford to pay because of two factors, said Ommeed Sathe, director of real estate development for the New Orleans Redevelopment Authority. The cost of construction to meet new building codes has gone up. And after Katrina, the cost of homeowner’s insurance in New Orleans went up by a factor of 5. That is the equivalent “of raising the cost of housing for every single family by $50,000.” The combination of high construction costs and high insurance rates is ironic,

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48 INCREASING NATIONAL RESILIENCE TO HAZARDS AND DISASTERS said Sathe, because the insurance industry could drop its rates if a large enough pool of new homes built to code existed. Hurricane Katrina was not a wind event. Almost all of the losses were caused by levee failures and the resulting flooding. Yet flood insurance costs about the same now as before Katrina, while homeowner’s insurance, which covers wind losses, has gone up by a factor of 5. In part, that reflects the “psychology” of the insurance industry, said Sathe. This “radical mispricing,” said Sathe, reflects psychological “anchoring to the recent event, regardless of what the actuarial rates are.” Traditionally, the insurance industry has had to get a large enough pool to diversify losses over space or time. But when risks tend to cluster, as when mul - tiple hurricanes hit the same areas, losses are not easy for conventional channels to handle. Are there other ways to bear and cover risks, Sathe asked. Similarly, are there better ways to price for risk and mitigation effectively? Improvements that would benefit everyone from the insurance companies to homeowners to government are undercut by skewed incentives, said Sathe. For example, his agency has adopted a fortified standard plus an energy efficiency standard. But these improvements are not reflected in increased appraisals, which would enable higher mortgages. Instead, the improvements have to be subsidized until the data are available to allow market pricing to occur. One challenge in changing incentives is the “invisibility” of insurance. Because homeowner’s insurance is included in the mortgage payment, people tend not to pay much attention to it. Furthermore, what they pay for insurance is not connected to mitigation measures. Research by behavioral scientists could help reveal ways to increase the salience of insurance pricing. Sathe suggested that homeowners could receive a monthly insurance statement, like a utility bill, specifically spelling out what coverage they are getting to make them more aware. Much of what it takes to fortify a house is relatively cheap, said Sathe, like thicker nails. “It would be one thing if these were $50,000 or $60,000 improve - ments. But if you’re doing new construction, the cost of fortifying is $6,000.” One reason the improvements do not occur is because of the culture of the design and construction industries. Tradesmen “do things the way their dad did it and their grandfather did it, and changing that is . . . a cultural shift.” Also, much scientific and engineering knowledge is not transferred into the communities that have to effectuate that knowledge, whether it’s the building permits department, the code inspectors, or local tradesmen. As an example, Sathe cited permeable concrete, which he described as a “much better product than regular concrete.” Water can drain through it, and it is cheaper to pour. But no one in Louisiana was certified to pour permeable concrete until the Make-It-Right Foundation funded training sessions, after which the use of permeable concrete began to propagate naturally. Similarly, other improvements can trickle into a community if people become familiar with them and consumers start to demand them.

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49 INSURANCE AND REAL ESTATE Communities are critical in setting standards, said Sathe. Federal standards are unlikely anytime soon, while local communities have immediate control over such basic factors as building codes, permitting, and enforcement. This is one of the ways in which something nebulous and fuzzy like social capital and commu - nity engagement has a real effect, said Sathe. Local communities also can deal with the realities of retrofits. For example, an improvement costing a couple of thousand dollars may not sound like a lot, but in New Orleans many people live from paycheck to paycheck and could not afford such an improvement. Banks may be able to finance such an improvement, but people in strained circumstances do not necessarily have the credit to qualify for financing. One way to finance such improvements might be through monthly charges such as those for utilities. Localities are well positioned to price capital improvements and have a vested interest in providing such improvements competitively. ADDING ACCOUNTABILITY TO AVAILABILITY AND AFFORDABILITY Later in the workshop, Michael Chaney, the insurance commissioner for the state of Mississippi, also addressed issues associated with insurance and building codes. All of the states along the Gulf Coast face a similar challenge, he said. Homeowners and business owners need insurance that is available, affordable, and accountable. “I say ‘accountable’ because it means if you have a valid claim, then the claim will be paid in the context of catastrophic events, whether hur- ricanes, earthquakes, or whatever.” Most people in Louisiana and Mississippi are experiencing sticker shock in buying insurance, and “there is no silver bullet to solve the problem.” If people build along the coastline, they have to build to a high standard, said Chaney. Roofs need to withstand category 4 hurricane winds. The frame of a house needs to be attached to a conventional foundation or slab with metal straps. Shutters, windows, and doors need to be reinforced. Mitigation also means not building in a floodplain. That is a problem for New Orleans, Chaney acknowledged, but proper land use generally means not building in wetlands. Building codes also need to be enforced. Chaney is in an unusual position because he became state insurance commissioner after helping to write a new building code law for the state, so he became responsible for enforcing his own law. One response has been to train building inspectors in the enhanced codes adopted in the state. Compliance rates are about 30 percent for the state, and com- pliance is mandatory in the five counties closest to the Gulf. “You have stronger building codes and you enforce them—it’s that simple.” When complaints about enforcement arise, Chaney points out the many steps the state can take to ensure adherence to codes. “You enforce the code and you reduce your risk. And you try to price the risk to the premium that you’ve got to pay to have insurance.”

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