(Bloomberg Business Week)
The Napa Valley earthquake in August offered another
instance of a well-known phenomenon: Homeowners are radically
underinsured against natural disasters. In California, 9 out of 10 homeowners don’t have earthquake coverage.
When Hurricane Sandy struck in 2012, 8 out of 10 affected residents
didn’t have flood insurance. This year’s hurricane season is forecast to
be mild, but there will be no shortage of opportunities to revisit
these statistics.
Homeowners’ insurance is normally a prerequisite
for obtaining a mortgage, but these basic policies don’t insure against
earthquake and flood, which require the purchase of separate coverage. Daniel Kahneman’s Thinking, Fast and Slow
provides insight into why so many people forgo this protection.
Intuitive, fast thinking works for most everyday actions but can fail us
when it guides decisions that we should make carefully, like
determining whether to buy insurance against low-probability
high-consequence events such as natural disasters.
When deciding
whether to take protective measures, we tend to rely on our own
experience in the recent past: We believe it will not happen to us,
because it has not happened to us recently. It had been more than 50
years since a coastal storm of Hurricane Sandy’s intensity hit the
Northeast. Adding to homeowners’ false sense of security, when Hurricane
Irene made landfall the year before, the predicted large-scale flooding
never materialized in the New York City area.
Immediately following a disaster, the calculus changes. The
uninsured who suffered damage wished they had purchased coverage, and
many decide to buy a policy. If there are no disasters within a few
years, many homeowners are likely to cancel their insurance because they
then feel their premiums have been wasted. Our analysis of the National
Flood Insurance Program database revealed that about half of new flood
insurance policies were canceled after just three or four years.
In
other words, fast thinkers view insurance as an investment rather than
as a protective measure, as revealed through dozens of empirical studies
in several disciplines. It is hard to convince individuals that they
should celebrate the serious loss that didn’t happen, rather than bemoan
the premiums paid for naught.
Are there ways to deal with this
problem? Research shows that homeowners can be persuaded to consider
insurance simply by recharacterizing the risks they face. Property
owners in a flood-prone area are far more likely to take the flood risk
seriously if they are informed that there is a greater than 1-in-5
chance (precisely 22 percent) of at least one flood occurring in the
next 25 years, instead of learning that they are in a “one-in-100-year
flood plain” (as defined by the Federal Emergency Management Agency).
These two probabilities are equal, but they don’t seem the same to
homeowners.