Howard Kunreuther

1
Public-Private Partnerships for Reducing
Environmental Risks The Role of Insurance,
Inspections and Regulations

• Howard Kunreuther
• Center for Risk Management and Decision Processes
  
• The Wharton SchoolUniversity of
  Pennsylvaniakunreuther_at_wharton.upenn.edu
• Paper Presented at
• Performance Track Participants Association (PTPA)
  Conference
• Baltimore , MD
• April 21, 2004

2
Linking Risk Assessment with Risk Management
Programs
Risk Assessment
Third Party Inspections
Risk Management Programs
3
Risk Assessment

• Quantifying Risk
• Protective Measures and Remediation (Reducing
  Risk)
• Environmental, Health and Safety Impacts

4
Third Party Inspections

• Experience Rating
• Monitoring
• Compliance

5
Risk Management Programs

• Economic Incentives
• Third party inspections
• Insurance premiums reflecting risk
• Well-specified Standards (Risk Management Plans)

6
Role of Inspection and Insurance

• Inspection can reveal ways individual company can
  reduce its safety and legal risks
•  
• Analysis of all inspection data can identify
  patterns to reduce safety risks
•  
• Insurers want inspections to be complete enough
  because otherwise they lose in claims
•  
• Insurers should reduce premiums to reflect lower
  risk
• Questions
• When do expected benefits of risk reduction
  justify the costs?
• When should insurance be mandatory rather than
  voluntary?

7
Overview of RMP Third Party Audit Concept

• Voluntary participation
• EPA establishes qualification standards
• Facility hires auditor
• Comprehensive RMP audit performed
• Auditor provides report to facility
• Facility takes corrective action and submits
  report to EPA
• EPA provides regulatory benefits

8
Need for Well Enforced Risk Management Plans

• How Individuals and Firms Treat Probabilities
•  
• People cannot distinguish between 1 in 10,000,
  1 in 100,000 and 1 in 1 million Kunreuther,
  Novemsky and Kahneman (2001).
• Managers rarely ask for probability information
  nor mention it in verbal protocols Huber, Wider
  and Huber (1997)
•  
• Externalities Affecting Residents Near Firm
•  
• Industrial facilities not liable for impacts on
  residents near plant
• (e.g. decreases in property values)
•  
• For every 1 borne by industrial firm there are
  an additional 5in social costs not borne by the
  firm. (Ashford and Stone 1991)
•  

9
Advantages of Third Party Inspections in Relation
to RMP Info

• Enables One to Distinguish Low-risk From
  High-risk Firms
• Link to RMP Accident Data Base
• Incorporating Decision Processes of Firms
• Links private and public sectors
•  
• Low-Risk Firms Can be Rewarded for their
  Performance
• Lower Insurance Premiums
• Stamp of approval by EPA (Good Housekeeping
  Seal)
• Vote of confidence by community (Good neighbor
  policy)
• For More Details See Collins et al (2002)
  and
• 
  Kunreuther, McNulty and Kang (2002)

10
Pilot Experiment

• Audited 21 chlorination and ammonia refrigeration
  facilities in Delaware and PA with third party
  inspectors
• Inspectors from insurance companies (Zurich,
  Environmental Compliance Services)
• Auditor training provided by Delaware Dept. of
  Natural Resources and Environmental Control
  (DNREC) and EPA Region III
• Training materials provided by Chlorine Institute
  and International Institute of Ammonia
  Refrigeration (IIAR)

11
Pilot Experiment Relevant Findings and
Recommendations

• Desirable qualities for auditors include
• Auditing experience
• Engineering background
• Chemical industry experience
• PSM/RMP knowledge
• Interpersonal auditing skills
• Experienced auditors can be ready for
• RMP audit with two days training

12
Lack of Interest in Voluntary Insurance

• Why firms dont purchase insurance
• It cannot happen to me
• Large firms---self insure
• Small firms---budget constraints
• Catastrophic risk is unattractive to insurers
• Ambiguity of risk
• Relatively small premiums
• Fear of large losses

13
Critiquing Mandatory Insurance

• Rationale for mandatory insurance
• Insurers have financial incentive for identifying
  key risk factors
• Government can adjust rules based on shared
  information
• Government can identify non-insured firms
• Problems with mandatory insurance
• Insurance industry does not want to be viewed as
  policeman
• Insurers may feel they cannot accurately set
  rates based on risk (e.g. terrorism)
• Government can adjust regulations only if
  insurers share data
• May be politically difficult to sell

14
Successful Mandatory Insurance Programs Steam
Boilers

• Historically inspections and insurance were
  coupled
• Inspections led to safer designs
• Insurance provides protection against losses from
  accident 
• Status of protection today
• Almost all States require annual inspections of
  pressure vessels
• Firms normally purchase insurance against boiler
  accidents
• Boiler accidents are rare
• For more details see Er (1999)

15
Successful Mandatory Insurance Programs Workers
Compensation Insurance

• Has always been in States hands
• Rationale for insurance is due to large
  litigation costs to workers
• Workers compensation insurance is a no-fault
  mechanism
• Program covers almost every worker in US
• Premiums are experienced-rated
• Firms have financial incentives to reduce risk
  levels.
• Some debate on whether workers comp has increased
  worker safety
• For more details see Moore and Viscusi (1990)

16
A Program For Rating and Reducing Risks
(Insurance/Inspections/Regulations)

• Importance of private inspections
• Enable the insurer to estimate losses
• Insurer can provide guidance to firms on
  risk-reducing measures
• Private inspector can certify that regulations
  have been met.
• Gathering risk information
• Rewarding firms for reducing risks
• Use of claims data to modify existing standards,
  set rates and improve inspection protocols

17
Future Research Challenges in Utilizing Private
Inspections

• Maintaining confidentiality and reporting
  hazardous information to regulator
• Ability of inspectors to determine how safe a
  firm actually is
• Asymmetry of information between firms, insurers
  and inspectors
• Maintaining confidentiality of a sound inspection
  process while making sure workers/public are
  adequately protected

18
Future Research Improving Risk Assessments

• Need to collect better data on which to determine
  risk-based premiums
• Accident history data from the U.S. Chemical
  industry,
• Role of precursors to improve environmental,
  health and safety
• Syncrude Canada Ltd. used precursors to reduce
  accidents
• 1.6 million rebate on workers comp at end of
  2002
• Current rate is .23 per 100 in payroll compared
  to 11/100 in roofing industry.

19
Future Research Utilizing Voluntary Insurance

• Example Coverage for asbestos contractors
• EPA and OSHA issued regulations for asbestos
  removal work in 1980s
• Insurers offered coverage for contractors
  involved in asbestos removal work
• Insurance became a license to do business
• Insurance is viewed as a signal for safety.
• Question How can we utilize voluntary insurance
  more effectively?

20
Summary

• Proposed program of insurance coupled with
  private and government inspections to enforce
  regulations
• Should reduce risk over the current regulatory
  system
• Can generate more information about firm
  practices than under the current system
• Should enable government agencies to craft more
  effective regulations

21
Questions For Discussion

• How can one establish credibility for third party
  inspectors in todays environment?
• How can one convince industrial firms that it is
  beneficial for them to utilize third party
  inspections?
• What is the inspectors obligation to report to
  the regulatory agency if they discover a highly
  risky situation in a firm they audit? (e.g. OSHA
  experience)
•  How desirable is it to make insurance mandatory?
  What role can private sector institutions (e.g.
  banks and financial institutions) play in the
  process (e.g. requiring insurance as a condition
  for a mortgage) ?
• Are there lessons from workers compensation
  insurance that can be applied to problems of
  environmental risk?

22
Selected References

• Ashford, N. A and Stone, R.F. (1991). Liability,
  innovation and safety in the chemical industry in
  P.W. Huber and R.E. Litan (Eds) The Liability
  Maze Washington, D.C The Brookings Institute
• Collins, L.et al (2002) The Insurance Industry as
  a Qualified Third Party Auditor Professional
  Safety
• Er, J.P. (1996). A third party approach to
  environmental regulation and possible roles for
  insurance companies. PhD Dissertation, University
  of Pennsylvania.
• Huber, O., Wider, R., Huber, O. (1997). Active
  information search and complete information
  presentation in naturalistic risky decision
  tasks. Acta Psychologica, 95, 15-29.
• Kunreuther, H. Novemsky, N. and Kahneman, D
  (2001). Making low probabilities useful. Journal
  of Risk and Uncertainty 23 103-120.
• Kunreuther, Howard, McNulty, Patrick and Kang,
  Yong (2002) Improving Environmental Safety
  Through Third Party Inspection Risk Analysis.
  22 309-18.
• Moore, M., Viscusi, K. (1990). Compensation
  Mechanisms for Job Risks Wages, Workers
  Compensation and Product Liability. Princeton
  Princeton University Press
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