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HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 145 PERSPECTIVE original typesetting files. Page breaks are true to the original; line lengths, word breaks, heading styles, and other typesetting-specific formatting, however, cannot be About this PDF file: This new digital representation of the original work has been recomposed from XML files created from the original paper book, not from the retained, and some typographic errors may have been accidentally inserted. Please use the print version of this publication as the authoritative version for attribution. Hazard Compensation and Incentive Systems: An Economic Perspective Howard C. Kunreuther Societal problems involving risk and uncertainty pose special challenges for economics, since standard approaches such as benefit-cost analysis and market-based mechanisms fall short in dealing with them (Arrow, 1983). This paper examines alternative incentive and compensation systems for dealing with potential hazards from both new and older technologies where one or more of the relevant stakeholders face a low-probability event with a potentially catastrophic outcome. The discussion revolves around two broad areas of current interest: 1. Adopting protective mechanisms: How can individuals be induced to protect themselves against the potential consequences of hazards, for example, by wearing seat belts when in automobiles or by purchasing insurance against floods or earthquakes? In these cases there are clear benefits to society in having people protect themselves, although few have voluntarily done so: fewer than 15 percent of drivers and passengers in automobiles wear seat belts voluntarily (Arnould and Grabowski, 1981), and few individuals purchased flood insurance despite its being highly subsidized by the federal government (Kunreuther et al., 1985). 2. Siting technological facilities: How can an appropriate location for a new technological plant such as a liquefied natural gas (LNG) terminal or a hazardous waste facility be determined? These facilities frequently evoke objections from local peopleâcommunities usually favor such a facility only if it is located elsewhere (Popper, 1983). Can a meaningful compensation mechanism be designed for sharing the gains of potential winners in such situations with people in the same situation who perceive themselves as losing?