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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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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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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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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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