The Fatal Flaw of Cost-Benefit Studies

Insurance companies calculate premiums based on the probability of claims. They often refuse to issue coverage for potential losses when the risks of someone collecting on insurance are too high.

You would think decisions to protect oceanfront buildings against beach erosion by pumping sand, moving inlets or building terminal groins would be made in a similar fashion. Such protection efforts are only worth pursuing when risks of losses once the projects are built are low. That’s why when such projects are considered a cost-benefit study is normally undertaken.

These studies attempt to evaluate whether the economic benefits resulting from these projects are worth the investments it takes to achieve them. It all sounds logical and simple. Don’t waste money paying for projects that cost more than the benefits they derive.

However, when it comes to determining the costs and benefits of projects proposed to protect oceanfront buildings, there is a fatal flaw in the cost-benefit analysis that is typically done.  These studies fail to adequately reflect the inherent risks associated with protecting buildings in such unstable, highly dynamic areas.

This became clear during discussions at the Coastal Resources Commission’s science panel meeting in December. Tom Jarrett, a member of the panel and an engineer who works for applicants who want to build terminal groins and other beach stabilization projects, told the group that oceanfront properties could still be severely damaged no matter what’s done to protect them.  Thus, he didn’t want projects he engineers to be blamed for losses that would occur whether or not his projects are built.

Jarrett’s concerns are well grounded.  A major hurricane or northeaster will cause lots of damage no matter what we do to try to mitigate their impacts. The probability of damage is so high that most private insurance companies no longer want to do business in these beachfront areas. Jarrett doesn’t want his projects to be blamed for damages that are inevitable whether or not his projects are built.

That’s fine and good; except that the analysis of costs and benefits used to justify projects he and others want permission to build do not factor in these inevitable losses either. Cost-benefit analysis generally assumes that property that is lost under a “no action” alternative will be saved when an “action” is taken. The 100 percent “saved” value is considered a direct project “benefit.”

But in reality, those long-term predicted benefits will only be realized if the ocean remains placid, and the tide never rises. It is much more likely that there will be significant property losses under any management alternative, but cost-benefit studies that account for those losses will show much less economic benefit associated with any preferred action alternative.

Probabilities of property losses under each management alternative during the projected life of a project need to be calculated.  These probabilities then need to be used to more accurately estimate project benefits. Estimates of economic benefits will change radically if you’re simply buying a few extra years for properties versus protecting them in perpetuity.

Clearly, property insurers are not confident that projects installed to protect oceanfront structures will work during major storm events. No insurance premium discounts are offered in locations where these projects have been constructed.   These areas are still view as highly hazardous.

Any economic analysis of benefits and costs that ignores these known risks is pure speculation when it comes to making cost-effective management choices, and little more than an exercise in wishful thinking.

About the Author

Todd Miller

Todd founded the North Carolina Coastal Federation in 1982. A native of Carteret County, he was selected in 2013 as a distinguished alumni of the University of North Carolina at Chapel Hill where he received his undergraduate and masters degrees. Todd also received The Old North State Award in 2007, the National Wetlands Community Leader Award in 2012 and the Peter Benchley Ocean Awards' Hero of Seas Award in 2015. He is a founding board member of Restore America Estuaries, a member of the Board of Visitors for the UNC Institute for the Environment and chairman of the Policy Committee for the Albemarle-Pamlico Estuary Partnership. As executive director, Todd formulates the federation’s goals and policy positions, serves as the federation’s spokesperson and provides staff and operations oversight.