Much has been written about the financial behavior of people living in disaster-prone locations. Do they buy insurance? How much do they buy? Over and over again we have seen fewer people than expected invest in robust insurance. There are psychological reasons for this: people never think a disaster will happen to them (not to mention the fact that insurance is expensive, especially in high risk locations). It is an equation in which actual risk plays second fiddle to perceived risk. We often hear about the poor homeowner who is denied insurance, but what about the poor insurance company working against the biological odds? Psychology tells us that humans are, innately, less likely to worry about property loss than insurance companies hope they will be.
“Human beings are hard-wired to believe in their heart and soul that disasters don’t happen and won’t happen to them,” says Dennis Mileti, a retired University of Colorado sociology professor. “Human beings are not rational when it comes to risk. Rationality is a myth invented by the Italians in the Renaissance.”
Understanding human risk-denial illuminates an inherent bias in the way we do business. While the individual human being may feel immune from risk, the insurance companies have a vested interest in fear. The more fearful a homeowner is about her disaster risk, the more money she will be willing to pay to protect herself. But, the more disaster-prone the home is, the less willing the insurance company will be to insure it. So the insurance company hopes for an unrealistic fear, while the homeowner convinces herself there is no reason to be afraid.
This is not to say homeowners don’t buy insurance. Certainly they do. And it is not to say insurance companies don’t make a killing. But it does illuminate an interesting interplay in the system. Homeowners convince themselves they’re safe until it becomes blatantly clear that they aren’t, and once that happens they can no longer get insurance because it’s so clear that they need it. Say, there is a wildfire that destroys a neighbor’s home, or an earthquake in a nearby town. Once homeowners are sufficiently convinced by disaster that they need insurance, the insurance companies, having run the numbers on the recent disaster, are no longer willing to offer it. So, the insurance companies continue collecting from the relatively safe few who get over their innate feelings of safety and buy insurance, and the rest, the desperate people in disaster zones thrust into fear by circumstance, are left without insurance at the time they need it most.
How is a system like this corrected? Mandatory insurance would correct the perception issue, but nobody wants to be forced into paying for insurance. Mandating that insurance companies cover everyone isn’t a solution either, since homes on the sides of cliffs aren’t smart decisions on anyone’s part. The best solution is the most complex, as per usual. Insurance companies that fairly assess overall risk, regardless of random happenstance and homeowners who make responsible decisions about the protection they need. Also, pigs should fly.
“When it comes to human beings, there is no such thing as objective risk. There’s only perceived risk.” – Dennis Mileti
References and Resources:
Between Hope and Fear: The Psychology of Risk