While Kunreuther has spent much of his professional life studying people’s attitude to risk, his personal life includes activities such as skiing, motorcycle riding, and white-water canoeing, reflecting a belief that risks are worth taking. His motorcycling has included trips from Texas to Mexico City and Chicago to Washington and a trip with friends from Salt Lake City, Utah, through Idaho to Jackson Hole, Wyoming, with his wife Gail riding on the back of a Harley Softail. He describes motorcycling as “a sport you do with all the five senses—it makes you totally aware.”

He’s an even greater fan of the bicycle, both as a means of transport and of recreation. In addition to more than 30 years of commuting to Wharton by bicycle, he has taken long trips, such as a 500-mile journey from Philadelphia to Vermont to raise money for research into Parkinson’s disease, from which his father died. For the first half of that trip, he was accompanied by his son, a professional jazz guitarist and then joined by his daughter, an anthropology professor at Bard College in New York State.

Kunreuther’s appetite for adventure has had tragic consequences. While snorkeling in Jamaica on a trip celebrating 19 years of marriage to his first wife, the couple was hit by a motorboat, killing his wife and almost killing Kunreuther. The incident has led him to campaign for propeller guards to be fitted on such vessels. He has been married to his second wife, Gail Loeb, a social worker, since 1990, and their family now includes four adult children.

Kunreuther’s current focus on terrorism is the extension of studies that go back some 40 years into ways of managing the risk of natural disasters such as floods, hurricanes, and earthquakes. On a trip to Alaska after a major earthquake there in 1964, he discovered that many people weren’t insuring themselves against quake damage—despite the region’s vulnerability to such events—because they didn’t believe it would happen to them. After the earthquake, residents lobbied for and received federal disaster assistance, and some ended up better off than before the quake because they obtained forgiveness for past debts.

Kunreuther discovered that people were more likely to insure themselves against relatively likely  events—even though those events had a limited impact—than they were against much rarer events, like an earthquake, that had devastating consequences. “People were not making decisions in a rational way,” says Kunreuther, an economist by training. “It got me thinking about how to deal with low-probability events.”

He developed his behavioral theories with a study of the reaction to Tropical Storm Agnes in the northeastern United States in 1972, which caused some $2 billion in damage. Few homeowners had flood insurance, despite its being heavily subsidized, and the Small Business Administration ended up giving $5,000 grants and 1 percent loans to uninsured victims.

“Our conclusions … suggest that individuals have a difficult time dealing with the concept of probability and tend to rely on salient data (e.g. past experience) and easily accessible sources (e.g. friends and neighbors) rather than utilizing
statistical data and making tradeoffs between benefits and costs,” Kunreuther wrote in “A Conceptual Framework for Managing Low-Probability Events,” a chapter in Social Theories of Risk, a 1992 book edited by Sheldon Krimsky and Dominic Golding.

In Pakistan, during a one-year stay at the Institute of Development Economics in 1970-1971, Kunreuther did further research into behavioral influences over economic decision-making, and discovered that rationality sometimes underlies apparently irrational acts.

He conducted a study of farmers to see who was more inclined to grow rice, a food crop, or jute, a cash crop. Expectations were that poor farmers would grow more rice because they needed the food, while richer farmers would devote more land to jute. But he found that the very poor farmers gambled by growing more jute than all but the richest ones.

The explanation, he found, was that the poor farmers were prepared to take the risk in an effort to get out of debt while their rich counterparts could afford to take a chance on boosting their income. “It was quite rational on one level but looked irrational,” he says.

Kunreuther’s conclusions about economic behavior often went against prevailing models that assumed rationality, says Paul Slovic, a psychology professor at the University of Oregon who has worked with him since the early 1970s. “It’s a hallmark of Howard’s work,” Slovic says. “He’s not afraid to depart from many models.”

In his work on floods, Kunreuther discovered that people were not only failing to cover themselves against catastrophic risk but were becoming a drain on the public purse when disaster struck.

By drawing on behavioral psychology to explain decision-making on insurance, the Alaska experience also illustrated Kunreuther’s willingness to take an interdisciplinary approach to his work, Slovic adds. “He’s very open to ideas that may just lead to better policy. He’s not wedded to any ideology.”

Kunreuther himself makes the point in his Conceptual Framework essay, noting that sociological and psychological factors are an important influence on economic behavior and must be considered by policymakers. The implication is that government must have some involvement in the market in order to counteract the irrational behavior of many consumers towards disaster protection, and to avoid paying billions of dollars in disaster relief.

In the case of flood insurance, the government’s response was the Flood Insurance Act of 1968, a law that Kunreuther’s research influenced, requiring homeowners with federally linked mortgages to buy flood insurance.

Foreshadowing the current debate—and the likely resolution—over terrorism coverage, he concluded almost 40 years ago that the management of low-probability, high-risk events was legitimately a matter for a public-private partnership. “There is an inability for the private sector alone to deal with low-probability events,” he says.

The failure of market-based mechanisms to spread the risk of terrorist attack supports this point. Reinsurers are unlikely to return to the market with any significant capacity because of the uncertainties of the risk, and catastrophe bonds have not been issued in any meaningful quantity.

“Neither of those risk-transfer mechanisms seems especially promising today,” Kunreuther and Erwann Michel-Kerjan wrote in a Spring 2005 article in Regulation magazine. “A sustainable market to cover losses from terrorist attacks has not emerged in the wake of September 11.”

Another possible private-sector solution is a mutual insurance pool, where the risk of terrorism coverage would be spread among a large number of insurers who join the pool. But the idea was undermined by a 2004 Towers Perrin study of 14 U.S. workers’ compensation insurers, which found that while the pool would create some additional capacity, it would be nowhere near enough to offset losses from a major terrorist attack. Such an attack could inflict workers’ compensation losses of $90 billion, three times the industry’s capacity for covering terrorism, the study found.

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©2005 The Pennsylvania Gazette
Last modified 07/02/05

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FEATURE: Insuring Against Terror