Excercise 25 Econ 417: Federal Emergency Management Agency

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EXCERCISE 25 ECON 417
Q: Suppose you are an analyst for FEMA (Federal Emergency Management Agency). Would you use the above model with person n replaced by region n and L replaced by disaster and H replaced by no disaster? Explain.
There are various hazard potential damages that are likely to occur and challenge then is to overcome these hazards and identify mitigation measures to minimize the impact of these hazards. FEMA (Federal Emergency Management Agency) considers risk management practices to eliminate the severity of disaster consequences and also seek to use resources more efficiently. Similar to the insurance model that considers the probabilities of disasters occurring and failing to occur is considered in risk mitigation, risk control measures include activities to limit and avoid the risks and when there are unavoidable risks, these are transferred to other parties. At other times, the insurance companies take care of the unavoidable risks through financing. Insurance is necessary to transfer the insurable risk to the insured. This paper looks at the appropriateness of a model depicting independent risks and insurance as is applicable to FEMA.
The proposed model assumes that there are two scenarios, either no disaster happening (Wh)/ H (probability π) or there is disaster (Wl)/ L (probability (1-π). For the insurance risk to work, it is assumed that the likelihood of an event occurring is quantifiable, and in this is the case as there are the damage causes by the hazard or disaster. The probability of occurring and not occurring all add up to one, as it is assumed that the event may either occur or not occur. Similarly, FEMA can use the proposed model as there are two scenarios depicting the likelihood of disaster and the likelihood that there will be no disaster.
The case for the proposed model is that FEMA would use past information and predictions to determine likelihood of disasters occurring and the resultant damage. Even though, FEMA would have no access to all the information, the example of relying on the insurance example is that it is possible to make decisions based on the information available. The challenge then is determining what information is appropriate in making decisions and what has no impact. Failure to make these distinctions means that FEMA is likely to make decisions that grossly underestimate or overestimate the impact of disasters. This is common in cases of asymmetric information where one entity has some information that the other entity and since there is hidden information that is not available to all there are cases of adverse selections in the insurance market.
When making decisions under uncertainty it is necessary to consider the case of state preference as this affects the investment decisions. In the complete capital markets there is symmetry of information such that the value of the firms is independent of the capital structure (Hirshleifer 264). Similarly, FEMA, would consider the expected losses when choosing the most optimal insurance and financing options. The case for this is that the capital budgeting decisions determines the expected returns, and the dollar claim is dependent on the calculated value of the insurance cover.
Even as information plays a crucial role when making decisions under uncertainty, differences in access to information alone cannot explain how rational agents make decisions (Serrano-Padial 1). There is an element of speculation in the capital markets when traders also choose investment decisions based on expectations, that is not necessarily grounded in research. The implication of this for FEMA, is that the agency would have to consider assumptions on the factors that influence the likelihood of disasters occurring. The allocation of resources in the no theorems approach assumes that there is a likelihood that one party will act more than others based on additional information (Serrano-Padial 2-3). One of the challenges that FEMA would need to deal with is access to information and disagreements on what is to be considered as relevant information. Under uncertainty it is likely that that the FEMA officials will speculated on different scenarios making it easier to identify the most relevant of these scenarios, as they get more information they are able to resolve some of the initial uncertainties.
The challenge of calculating costs and risks when there is inadequate information affects the ability of FEMA to provide disaster management services in the affected areas. Getting access to information that is relevant to calculating costs affects the probability of the disaster happening. To alleviate this problem then other models may be integrated to provide more certainty so that FEMA has better understanding of the disaster and the region affected.
As such, the model, while simplistic is appropriate for FEMA, but using accurate and timely information is crucial to the success of the agency’s operations during disasters and planning.
Measuring disasters requires estimation of the expected loss and the probability of damage/ruin. The expected loss may extend to the damage to buildings, loss of life and interruptions and it is assumed to be the average rate of loss that is expected (Chen and Tseng 661). To further represent the probability of ruin when there is a need for risk control measures and extra resources to deal with the loss (Chen and Tseng 661). for businesses, when there is a risk of loss from the natural disaster then it is more likely that they will establish the desire level of financial health to deal with the challenges of financial distress and economic costs associated with damages of the disaster (Chen and Tseng 661). The attributes that are considered in the disaster scenario are classified to predict the consequences of the disaster and emphasis is on avoiding the underestimation risk.
Chen and Tseng (668) consider the example of a business enterprise where managers have to consider building codes or purchasing insurance covering building codes and making decisions on risk management against disasters like earthquakes. In such cases costs are allocated to cover for the anticipated loss with the risk control budget allocations then being considered. The challenge of accessing reliable information means that the deterministic analysis in risk management is based on assumptions that may not hold true. It is also necessary to consider hazard characterization focusing on the probability of the hazard occurring in an area during a specified time frame as this helps in evaluating the differential disaster risk. Such an approach when applied to the insurance companies would allow them to focus more on the hazard probabilities in different locations, and they are likely to invest in areas in areas where they know the hazard probabilities...