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New solutions to cover future catastrophic losses would include a mix of public-private partnerships and greater uses of alternative risk transfer mechanisms, according to a new report by the Wharton Risk Management and Decision Process Center. The center is part of the highly regarded business school, the Wharton School at the University of Pennsylvania.

The study, directed by Howard C. Kunreuther and Erwann O. Michel-Kerjan, calls for adjusting insurance premiums to more accurately reflect risk and to provide "special treatment" to uninsured or underinsured homeowners living in hazard-prone areas.

The 387-page study, released in March, also underscores the role that public-private partnerships play as a way of mitigating risks in an age when property values at risk of damage or loss measure in the trillions of dollars and when economic losses due to natural catastrophes are rising.

From 1950 to 1959 economic losses from catastrophes measured $53.6 billion; from 1960 to 1969 losses cost $93.3 billion; from 1970 to 1979 losses rose to $161.7 billion; from 1980 to 1989 losses again went up to $262.9 billion; and from 1990 to 1999 the damage soared to $778.3 billion.

"The question is not whether catastrophes will occur, but when, and how frequently they will strike, and the extent of damages they will cause," the study's authors write. As a result, they said, a national risk management policy blueprint is necessary to help policymakers develop mitigation strategies.

Public-private partnerships already under way include the proposal of a coastal hurricane zone that would standardize construction codes across states in the zone, according to the report.

Surplus from premiums collected during the quiet years would be redistributed to homeowners in active years, and deficits met through surcharges. Such a mechanism would reassure private-sector carriers and encourage them to make long-term commitments of capital to cover wind damage from hurricanes, according to Kunreuther and Michel-Kerjan.

Another proposal under consideration by Congress is the creation of a national catastrophe fund, which would provide a pool of last resort for state catastrophe funds and private reinsurance.

The report also proposes a system of auctioning reinsurance contracts that could be used to cover only the most costly or catastrophic events; and the expansion of alternative risk transfer instruments to make them easier to buy and sell.

And finally, the report proposes the creation of "a data collection and information sharing entity" to track how many homeowners have bought insurance and how much they have paid for it.

"This system could be implemented at a very small cost via the Internal Revenue Service, with homeowners answering a few questions about their property insurance coverage on their annual IRS tax returns," according to the authors of the report.

In addition to Kunreuther and Michel-Kerjan, Neil A. Doherty, Martin F. Grace, Robert W. Klein and Mark V. Pauly are cited as authors of the study.

June 1, 2008

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