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January 05, 2021 Article 2

Disaster Law and Policy: Accidents Waiting to Happen

by James Ming Chen

An ounce of prevention

            Natural disasters aren’t utterly unforeseeable events. We track hurricanes from their origins as tropical depressions. And spring flooding rather predictably follows a winter of heavy snow. To be sure, earthquakes are harder to predict than many other potential catastrophes. But these events do not lie beyond our forecasting powers.

The real question, as a matter of legal policy and economic wisdom, is why we spend so little to prepare for foreseeable disasters. An ounce of prevention is literally worth almost a pound of cure. By one estimate, each dollar spent on disaster preparedness is worth roughly $15 in mitigated future damage. In a note at the end of this essay, I will cite sources that perform this economic calculation. But even if this estimate is wrong by a whole order of magnitude, a rational person would still spend $1.00 to avoid losing $1.50.

The failure to take reasonable, even obvious steps in anticipation of natural disasters is a variation on a common legal theme. All facets of finance, from banking and investment to insurance, are branches of risk management. Miscalculations by hedge funds or actuaries are typically classified as mismeasurement of risk. In other circumstances, financial failures are blamed on the poor implementation of theoretically sound predictive models.

So which of these explanations accounts for poor management of risk from natural disasters? I will identify two mutually related causes.

First, natural disasters are big, rare, and destructive events that exceed the financial resources of individuals and businesses. Spending money before disaster strikes means spending money up front. We apply the metaphor of disaster planning to everyday conversation. We literally speak of “saving money for a rainy day.” An alternative to saving money is to transfer the risk through insurance. But private insurance companies have historically refused to cover certain losses, such as flood damage.

Although it’s certainly a contestable point, and probably cause for some controversy, natural disasters overwhelm the managerial abilities and resources of the private sector. The corresponding case for treating disaster management as a governmental responsibility is that much stronger. In The Sympathetic State: Disaster Relief and the Origins of the American Welfare State (University of Chicago Press 2012), Michele Landis Dauber argues that disaster relief may be the sole basis for governmental intervention in civilian life that draws support from all parts of the ideological spectrum.

Public-sector involvement in natural disaster management leads to my second criticism. If disaster management becomes a governmental responsibility rather than a set of duties left to individuals and private insurance companies, then disaster law becomes an instrument of politics. Alas, voters prefer heroic intervention over prosaic prevention. As a result, disaster management by the government can become a series of catastrophic responses to catastrophic risk.

Accidents waiting to happen

Across the landscape of disaster, from natural events such as hurricanes to losses more typically blamed on humans (including industrial accidents such as Three Mile Island and the Exxon Valdez), systematic underinvestment in prevention, precaution, and preparation leaves society awash in  “accidents waiting to happen.” Risk management can respond with four tools: avoidance, reduction, retention, and transfer.

If these are the four horses of risk management’s anti-Apocalypse, the hardest to feed and ride is risk transfer. Consider the problem of living by the sea. Along with the view and the maritime lifestyle comes risk associated with hurricanes, tsunamis, and rising sea levels. You can avoid the risk by living elsewhere, or at least building your house a little farther inland. You can reduce certain risks by building a sturdier house. Or you can retain risk by accepting the consequences of living seaside and setting money aside to rebuild when storms or waves eventually force the issue.

If you do none of those things, however, you have one last choice. You can transfer risk to someone else. Notably, the recipient of a risk transfer doesn’t have to be a voluntary partner. A successful lawsuit is said to transfer risk from the winning party to the loser. To say the least, this is an extreme way to execute a risk transfer strategy.

Recovery through tort suits requires proof that some individual or corporate defendant has breached a duty of care. Certain laws tailor recovery according to particular types of disaster.  For example, the Oil Pollution Act of 1990 imposes liability for “removal costs and damages” upon “each responsible party for a vessel or a facility from which oil is discharged … into or upon … navigable waters or adjoining shorelines.”

More typically, though, risk transfer is voluntary. Let’s return to our hypothetical seaside house. You may be able to buy insurance against some of the risks you encounter when you live by the sea. By issuing a policy, an insurance company has agreed to bear certain risks of seaside living, as long as you pay a periodic premium.

Risk transfer through homeowner’s or renter’s insurance is an ordinary, everyday transaction. As long as a house remains mortgaged, the lender will insist that the homeowner carry insurance, if only to protect the bank’s security interest. But few property and casualty insurance companies will underwrite a rider for earthquake damage. Even fewer will cover flood damage.

Limits on insurability arise from the nature of catastrophic loss. The pooling of risks remains profitable for insurance companies only to the extent that claims don’t happen at the same time and within a concentrated geographic area.
In other words, risks don’t exist in isolation. They often travel in packs and arrive at the same time. Economists and actuaries describe this problem as one of correlation.

For reasons deeply rooted in American history, culture, and politics, the business of insurance in the United States is regulated mostly at the state level. The McCarran-Ferguson Act, a federal statute passed in 1945, commits the regulation of insurance companies to state governments. As a result, American insurance companies have smaller geographic footprints — and lower financial reserves — than some of their counterparts in other wealthy countries.

But even the largest insurance companies avoid covering flood-related losses. The correlation of such losses in time and space is simply too severe for insurance companies to bear. The private sector does have ways to respond. The specialized business of reinsurance pools losses among insurers. Exotic instruments such as catastrophe bonds (which are often established as “special purpose vehicles” under the laws of financial havens such as the Cayman Islands) enable reinsurance companies to transfer some of their risk to very wealth individuals and institutions.

If all else fails, though, there is a reinsurer of last resort: the federal government. Through the National Flood Insurance Program, the United States government has subsidized insurance policies that will cover flood-related losses. Despite those subsidies, many homeowners have failed to buy flood insurance. Congress often passes ad hoc relief after many storms. Buying insurance, even at discounted rates, may not make financial sense if you expect a cost-free bailout from Congress.

Moreover, the NFIP has struggled to contain its costs. Although the Biggert-Waters Flood Insurance Relief Act of 2012 promised to put the NFIP on better financial footing by charging premiums reflecting the actual risk of flooding, this law resulted in sharp increases in premiums charged for flood insurance. A public outcry prompted Congress to delay or undo much of the original reform by passing the Homeowner Flood Insurance Affordability Act of 2014.

Catastrophic responses to catastrophic risks

            The federal government’s frustration in its efforts to reform flood insurance may not seem terribly dire. Other insurance programs, such as crop insurance for farmers, have faced similar problems. There, too, the habit of awarding ad hoc relief after disaster reduces or eliminates incentives to take preventive measures ahead of time.

But disaster policy isn’t just one program or one industry or losses from one type of severe weather. Proper social responses to disaster require coordination among private actors (including charitable relief agencies) and government agencies at all levels. A closer look at political and practical realities shows why disaster policy so often delivers catastrophic responses to catastrophic risks.

All sorts of inevitable events require advance planning. Bad health, old age, death… We can’t avoid these negative outcomes, but we can take measures to soften the blow to ourselves and our families. It is also true that smart preparation — proper diet and exercise, retirement and estate planning — takes effort. When it comes to getting ready for bad outcomes, most people fall far short.

So too with disaster. Scholars of disaster law spend much of their time urging individuals, private companies, relief charities, and governments to assemble a mixture of plans and policies. The goal is to strike the right balance between prevention, emergency response, compensation and insurance, and reconstruction. Perhaps the hardest trick is knowing how much to spend on advance preparation, as opposed to rescue efforts after the fact.

Certain services, such as education or law enforcement, are considered “public goods” because they are open to all. Not only are public goods widely available, but consumers can usually take advantage of them without getting in each other’s way. Until congestion clogs the quality of traffic or classroom instruction, people who make use of roads and schools don’t really reduce the value of these public goods to other people.

Investments in disaster preparedness are quite often public goods. Some of these investments, such as dikes or levees, are visible, even physically formidable. Others investments are virtual or analytical in nature, such as databases on flood vulnerability and early warning systems for storms and earthquakes.

For example, Congress has ordered the Federal Emergency Management Authority (FEMA) to develop a protocol and database for allocating losses between water and wind in “named” storms. The federal government  appropriates $400 million each year so that FEMA can produce flood maps in 100-year floodplains, 500-year floodplains, and “residual risk areas.”

Evidence supporting public-sector investment in disaster preparedness is global. In comparing recovery after disaster in richer countries with recovery in poorer countries, economists have concluded that economic resilience requires advance financial planning and reserves. With proper resources in place, countries can withstand the initial shock, prevent spillovers into the broader economy, and pay for reconstruction.
In every country, however, investments in disaster preparedness are subject to the no-holds-barred politics of taxing and spending. Rarely do politicians win campaigns by promising to bring actuarial soundness and proper management to the National Flood Insurance Program. It is very difficult to turn hurricane and earthquake databases into compelling political ads.

On the other hand, politicians look very impressive when they lead dramatic missions to rescue flood victims and deliver desperately needed food and medical aid. “Sending in the cavalry” makes great political theater. It is also very expensive, and almost always less cost-effective than advance investments in physical infrastructure and analytics.

In other words, sending troops, food, and medical supplies wins elections. It may be wiser to spend money on prevention, detection, preparation, and insurance, but politicians don’t care to stake their careers on measures that are as slow as they are dull. The Stafford Disaster Relief and Emergency Relief Act, a heroic and visionary law for delivering federal aid to state and local governments overwhelmed by disasters, has now become legal first aid rather than disaster assistance of last resort.

The politicization of disaster relief punishes even the politicians themselves.  When stricken areas realize sudden “windfalls” from federal funding, the influx of money creates conditions that invite corruption and waste. Not every elected official successfully resists the temptation.

In short, natural disasters aren’t the only things that make it hard to develop sensible laws and public policy. Human nature, especially the instincts that enable us to evaluate risk and to make smarter decisions in the future, is a formidable foe in its own right. Quite often, communities imagine that surviving a disaster means that a long period of calm and relative safety will follow. That assumption flies in the face of environmental probability. Nevertheless, the urge to restore a vulnerable waterfront to its previous glory is emotionally and politically irresistible. What is true of beloved beachfront homes is true of entire towns. We rebuild, only to suffer loss anew when storms return.

There’s no such thing as a natural disaster

It is often said that there is no such thing as a natural disaster. This apparent paradox reminds us that terrible physical events, from hurricanes to earthquakes, have social consequences. Nature lashes out, but human choices put vulnerable people in harm’s way.
Just as there is no such thing as a strictly natural disaster, there is no such thing as strictly private disaster law.  All sorts of calamities overwhelm the capability of ordinary citizens, companies, and private charities. Government at all levels has a role to play. Everything from flood insurance to dikes, levees, and storm-damage databases engages the public sector.

But because law is a human institution, we must temper our expectations of disaster law and policy. When government sends in the cavalry after the next catastrophe, we should remember that it might have been wiser and cheaper to spend money on duller acts of disaster preparedness in advance. Memories, of course, are short. Soon enough, we’ll vote against spending money during periods of calm, and wait for calamity to strike again.

            Note — The economic estimate that each dollar in disaster preparedness saves $15 in future damage is based on these sources:

  1. M. Ishaq Nadiri and Ingmar Prucha. 1996. “Estimation of Depreciation Rate of Physical and R&D Capital in the U.S. Total Manufacturing Sector.” Economic Inquiry, volume 34, pages 43-56.
  2. Andrew Healy and Neil Malhotra. 2009. “Myopic Voters and Natural Disaster Policy.” American Political Science Review, volume 103, pages 387-406.