Managing Environmental Risk through Insurance (2002)

Managing Environmental Risk Through Insurance, by Paul H. Freeman and Howard Kunreuther, 1997, Boston: Kluwer Academic Publishers Managing Environmental Risk Through Insurance is the ninth publication in the Kluwer series Studies in Risk and Uncertainty, edited by Professor W. Kip Viscusi. Authors Freeman and Kunreuther (FK) provide an excellent addition to the series, exploring the issue of private insurance can be used as a means to obtain compliance with governmental environmental (vii). Although targeted primarily at policymakers, the book is clearly written and may prove useful to insurance academics as either a required or supplemental reading in a collegiate risk/insurance seminar. FK present their analysis in two sections, the first dealing with managing societal risks in general, and the second with managing certain environmental risks. The first section opens with three chapters comparing the management of societal risks through governmental benefits programs, the tort legal system, and insurance. In the first chapter, FK offer insights into various governmental programs (for example, low-interest disaster relief loans, federal subsidy of repairs to public structures and infrastructure, state guaranty funds). provide a balanced, compelling assessment in laying out key elements of their analysis. For example, FK postulate that the essential characteristic of governmental programs is the understandable tendency to emphasize equity over efficiency, without regard to need. Thus, government programs tend to encourage certain (undesirable) behaviors by focusing simply on a claimant's eligibility for benefits rather than whether the claimant should have avoided [the event] in the first place (8). FK observe that the primary advantage that such governmental focus on post-event benefits qualification has over pre-event planning is that lower unit administrative costs typically accrue in the benefits disbursement process. Yet FK clearly recognize the primary weaknesses of such government programs: They do nothing to lower the risk and likelihood of loss, and they subsidize certain individuals and businesses at the expense of all taxpayers (10). The second chapter examines the system of incentives inherent in tort law and presents a brief history of key environmental legislation in the United States governing clean water (1972), air (1977), and soil (through the Resource Conservation and Recovery Act [19761, CERCLA [1980], and EPA underground storage tank [UST] regulations). FK state that the polluter pays principle of strict liability, which was created through governmental shifting of responsibility for risk onto those perceived to have created it, was expected (incorrectly) by scholars to better spread risk and encourage loss control. FK thus present a strong case that the primary limitations of the tort system are in identifying actual causal links between exposure and injury, as well as the extraordinarily high transaction costs that reduce funding efficiency for remediation and cleanup. The third chapter discusses the historical significance of insurance in general, the specific features of insurance that make insurance attractive for managing societal risks, the role of reinsurance in creating markets, and the transaction costs associated with using insurance as a policy tool. The key features of insurance identified by FK include risk spreading, variance reduction in predicted frequency and severity of loss in setting reserves, segregation and categorization of risks to reduce cross-subsidization, the encouragement of loss control, the value of outside monitoring and inspection of insureds by insurers, and the role of reinsurance to further spread risk. The chapter closes with a brief discussion of payment capacity and transaction costs for general liability insurance and environmental claims. Although asbestos and CERCLA liabilities are distinctly different (28), FK state that the applicable transaction costs are of roughly the same magnitude (that is, with only approximately 40 percent of claims costs going to plaintiffs), based on certain RAND and American Academy of Actuaries studies of such claims. …