Federal disaster aid granted to communities hit by natural catastrophes causes demand for property insurance to fall by six times as much, according to a new issue briefing from the University of Pennsylvania’s Wharton Risk Management and Decision Processes Center.

Based on a working paper co-authored by Wharton’s Erwann Michel-Kerjan, along with Carolyn Kousky of Resources for the Future and Paul Raschky of Australia’s Monash University, the briefing notes that, for each additional $1,000 in average Individual Assistance grant size extended to residents of a particular ZIP code, average individual demand for insurance in that ZIP code fell by up to $6,000.

The researchers compared National Flood Insurance Program policies, flood claims and grants for uninsured losses extended through the Federal Emergency Management Agency’s Individual Assistance program. They examined data from Florida, home to 2 million NFIP policyholders, between 2000 and 2009, during which period the state saw a number of federal disaster declarations.

FEMA’s IA program offers compensation for uninsured property, such as unattached structures and landscaping, but typically requires that a homeowner must have primary insurance on his or her home. A major exception to that rule came in the wake of Hurricane Katrina, when FEMA permitted grants for flood damage to property owners who lacked flood insurance. The Wharton team found grants did not influence whether a property owner decided to purchase insurance, but only the amount of coverage they elected to buy, adding that the purchase “requirements seem to be well-enforced.”

Not only did the study find more significant moral hazard effects with larger assistance grants, but where assistance grants were the smallest – in the bottom quartile of the distribution – individuals actually purchased more insurance than they would have with no assistance. The researchers speculate this effect could result from property owners learning that the aid would be insufficient to cover their costs.

Interestingly, the same effects did not hold when the researchers examined post-disaster low-interest rebuilding loans extended to both businesses and homeowners by the U.S. Small Business Administration. Looking at the insurance purchasing decisions of communities that received significant volumes of SBA loans, researchers found “no systematic effect.”

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