Two Views of Risk in the Post-9/11 Era
Casualty Actuaries of New England
Dr L James Valverde, Jr
Vice President, Economics and Risk Management
Insurance Information Institute
110 William Street
New York, NY 10038
Tel: (212) 346-5522
Fax: (212) 732-1916
jamesv@iii.org www.iii.org
26 September 2006
Broad Outline
Two Views of Risk:
1. Managing Natural Catastrophes in a
Post-9/11 World
2. Government as Ultimate Risk
Manager — What Role Should the
Federal Government Play in
Managing Extreme Events?
First View:
Managing Natural Catastrophes in a
Post-9/11 World
Components of the First View
• Catastrophe Loss Management: The Hurricane Seasons
of 2005 and 2006
• Managing Natural Catastrophes – The Larger Context
• Emergency preparedness and response in the wake of
9/11
• Questions and emerging lessons from Hurricane Katrina
• The U.S. Department of Homeland Security
• Historic moment for America or bureaucracy writ large?
• Emergency Preparedness and Response
• All-hazards vs. terrorist myopia?
• FEMA – Challenges in the years ahead
• Implications for P/C Insurers and Reinsurers
• Transitioning Remarks  Second View
Catastrophe Loss Management:
The Hurricane Seasons of 2005 and 2006
Most of U.S. Population and Property has Major CAT Exposure
Is Anyplace
Safe?
2005 Was a Busy, Destructive, Deadly, and Expensive Hurricane Season
All 21 names
were used for the
first time ever, so
Greek letters
were used for the
final storms
Source: WeatherUnderground.com, January 18, 2006.
2005 set a new record for the
number of hurricanes &
tropical storms at 28, breaking
the old record set in 1933
2006 Hurricane Season: Much Less Active Than Expected
What a difference a
year makes! Just 8
named storms
through 18 Sept
2006 vs. 17 as of
same date in 2005!
Source: WeatherUnderground.com, September 17, 2006.
2006 Hurricane Season: Forecasts Repeatedly Scaled Back
275%
30
Named Storms
25
20
15
2006 hurricane seasons has
turned out to be far less
severe than anticipated
195%
140%
100%
10
5
Net Tropical Cyclone Activity
90%
26
17
10
300%
250%
200%
150%
100%
15
13
0
50%
Net Tropical Cyclone Activity
Named Storms
0%
50-Year 2005 Actual May 31
Average*
Forecast
August 3 September 1
Forecast
Forecast
*Average over the period 1950-2000.
Source: Insurance Information Institute compilation of forecasts by Dr. William Gray, Colorado State University.
U.S. Insured Catastrophe Losses ($ Billions)*
$61.2
$5.2
$27.5
$12.9
$4.6
00
$5.9
$8.3
99
$26.5
$10.1
$2.6
97
98
$7.4
96
$4.7
91
$8.3
$2.7
90
95
$7.5
89
$40
$16.9
$60
$5.5
$80
$22.9
2005 was by far the worst
year ever for insured
catastrophe losses in the US,
but the worst has yet to come
$100
$100.0
$ Billions
$120
$20
$100B CAT
year looms
on the
horizon
*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. ** As of June 30, 2006.
Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business
and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B.
Source: Property Claims Service/ISO; Insurance Information Institute
20??
06**
05
04
03
02
01
94
93
92
$0
Number of Major (Category 3, 4, 5) Hurricanes Striking the U.S. by Decade
1930s – mid-1960s:
Period of Intense Tropical
Cyclone Activity
Mid-1990s – 2030s?
New Period of Intense
Tropical Cyclone Activity
10
9
8
8
8
4
6
6
6
5
5
4
Tropical cyclone activity in the
mid-1990s entered the active
phase of the “multi-decadal signal”
that could last into the 2030s
6
Already as many
major storms in
2000-2005 as in all
of the 1990s
1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s
*Figure for 2000s is extrapolated based on data for 2000-2005 (6 major storms: Charley, Ivan, Jeanne (2004) &
Katrina, Rita, Wilma (2005)).
Source: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.
Top 10 Most Costly Hurricanes in US History, (Insured Losses, $2005)
$45
$40
$35
$ Billions
$30
$25
$20
$15
Seven of the 10 most expensive
hurricanes in US history
occurred in the 14 months from
Aug. 2004 – Oct. 2005:
$21.6
Katrina, Rita, Wilma, Charley,
Ivan, Frances & Jeanne
$10.3
$10
$5
$40.6
$3.5
$3.8
Georges
(1998)
Jeanne
(2004)
$4.8
$5.0
Frances
(2004)
Rita
(2005)
$6.6
$7.4
$7.7
Hugo
(1989)
Ivan
(2004)
Charley
(2004)
$0
Sources: ISO/PCS; Insurance Information Institute.
Wilma
(2005)
Andrew
(1992)
Katrina
(2005)
Insured Loss & Claim Count for Major Storms of 2005*
$45
$40
$35
$30
$25
$20
$15
$10
$5
$0
Claims
Hurricanes Katrina,
Rita, Wilma & Dennis
produced a record 3.3
1,047
million claims
1,744
$40.6
383
104
$1.1
Dennis
$10.3
$5.0
Rita
Wilma
Katrina
Size of Industry Loss ($ Billions)
*Property and business interruption losses only. Excludes offshore energy & marine losses.
Source: ISO/PCS as of June 8, 2006; Insurance Information Institute.
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
Claims (thousands)
Insured Loss ($ Billions)
Insured Loss
Hurricane Katrina Insured Loss Distribution by State ($ Millions)*
Florida, $572.0 , 1.4%
Alabama, $1,032 ,
2.5%
Mississippi, $13,605 ,
33.5%
Total Insured
Losses =
$40.579 Billion
*As of June 8, 2006
Source: PCS division of ISO.
Tennessee, $59.0 ,
0.1%
Georgia, $36.0 , 0.1%
Louisiana
accounted for
62% of the
insured losses
paid and 56% of
the claims filed
Louisiana, $25,275 ,
62.3%
Hurricane Katrina Loss Distribution by Line ($ Billions)*
Commercial
Property & BI,
$20,847.0 , 52%
Total insured
losses are
estimated at
$40.579 billion
from 1.7438
million claims.
Excludes $2$3B in offshore
energy losses
*As of June 8, 2006
Source: PCS division of ISO.
Vehicle, $2,168.0 ,
5%
Homeowners,
$17,564.0 , 43%
Hurricane Rita Claim Count Distribution by State*
Alabama, 5,000 , 1.3%
Arkansas, 5,500 , 1.4%
Florida, 6,000 , 1.6%
Tennessee, 3,500 ,
0.9%
Louisiana
accounted for
48.3% of the
insured losses,
Texas 44.6%.
Mississippi, 7,000 ,
1.8%
Texas, 171,000 ,
44.6%
Total # Claims
= 383,000
*As of June 8, 2006
Source: PCS division of ISO.
Louisiana, 185,000 ,
48.3%
Excludes
offshore energy
losses of $2-3B
Hurricane Rita Loss Distribution, by Line ($ Millions)*
Commercial
Property & BI,
$1,861.2 , 37%
Vehicles, $211.0 ,
4%
Total insured
losses are
estimated at $5.0
billion (excl.
offshore energy
of $2-$3B) from
383,000 claims.
Homeowners,
$2,974.2 , 59%
*As of June 8, 2006
Source: PCS division of ISO.
Hurricane Wilma Loss Distribution by Line ($ Millions)*
Commercial
Property & BI,
$2,200 , 21%
Total insured
losses are
estimated at
$10.3 billion
from 1.047
million claims
*As of June 8, 2006. All losses are in FL.
Source: PCS division of ISO.
Vehicle, $750 , 7%
Homeowners,
$7,350 , 72%
Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, 1986-2005¹
Wind/Hail/Flood5
2.8%
Earthquakes 4
6.7%
Winter Storms
7.8%
Terrorism
7.7%
Water Damage
Civil Disorders
0.1%
6 0.4%
Fire
Tornadoes 2
2.3%
Utility Disruption
24.5%
0.1%
Insured disaster losses
totaled $289.1 billion from
1984-2005 (in 2005 dollars).
Tropical systems accounted
for nearly half of all CAT
losses from 1986-2005, up
from 27.1% from 1984-2003.
All Tropical
Cyclones 3
47.5%
1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2005 dollars.
Catastrophe threshold changed from $5 million to $25 million beginning in 1997. Adjusted for inflation by the III.
2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions
and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood
Insurance Program. 6 Includes wildland fires.
Source: Insurance Services Office (ISO)..
Total Value of Insured Coastal Exposure (2004, $ Billions)
Florida
New York
Texas
Massachusetts
New Jersey
Connecticut
Louisiana
S. Carolina
Virginia
Maine
North Carolina
Alabama
Georgia
Delaware
New Hampshire
Mississippi
Rhode Island
Maryland
$1,937.3
$1,901.6
$740.0
$662.4
$505.8
$404.9
$209.3
$148.8
$129.7
$117.2
$105.3
$75.9
$73.0
$46.4
$45.6
$44.7
$43.8
$12.1
Florida & New York
lead the way for insured
coastal property at more
than $1.9 trillion each
$0
Source: AIR Worldwide
$500
$1,000
$1,500
$2,000
$2,500
Insured Coastal Exposure as a % of Statewide Insured Exposure (2004, $ Billions)
Florida
Connecticut
New York
Maine
Massachusetts
Louisiana
New Jersey
Delaware
Rhode Island
S. Carolina
Texas
NH
Mississippi
Alabama
Virginia
NC
Georgia
Maryland
79.3%
63.1%
60.9%
57.9%
54.2%
37.9%
33.6%
33.2%
28.0%
25.6%
25.6%
23.3%
13.5%
12.0%
11.4%
8.9%
5.9%
1.4%
0%
Source: AIR Worldwide
10%
20%
30%
40%
After FL, many
Northeast states have
among the highest
coastal exposure as a
share of all insured
exposure in the state
50%
60%
70%
80%
90%
Value of Insured Commercial Coastal Exposure (2004, $ Billions)
New York
Florida
Texas
Massachusetts
New Jersey
Connecticut
Louisiana
S. Carolina
Virginia
Maine
North Carolina
Georgia
Alabama
Mississippi
New Hampshire
Delaware
Rhode Island
Maryland
$1,389.6
$994.8
$437.8
$355.8
$258.4
$199.4
$121.3
$83.7
$69.7
$52.6
$45.3
$43.3
$39.4
$23.8
$20.9
$19.9
$17.9
$6.7
$0
Source: AIR
$200
$400
Commercial property
exposure also implies
significant business
interruption losses
$600
$800
$1,000 $1,200 $1,400 $1,600
The 2006 Hurricane Season:
Lowering Expectations
Outlook for 2006 Hurricane Season
Average*
2005
2006F
9.6
28
13
49.1
115.5
50
5.9
14
5
24.5
47.5
13
Intense Hurricanes
2.3
7
2
Intense Hurricane Days
13
7
4
100%
275%
90%
Named Storms
Named Storm Days
Hurricanes
Hurricane Days
Net Tropical Cyclone Activity
*Average over the period 1950-2000.
Source: Dr. William Gray, Colorado State University, September 1, 2006.
Probability of Major Hurricane Landfall (CAT 3,4,5) in Sept/Oct 2006
9/06F
Avg.*
10/06F
Avg.*
Named Storms
74%
67%
22%
29%
Hurricanes
59%
48%
14%
15%
Intense Hurricanes
35%
27%
4%
6%
*Average over past 52 years.
Source: Dr. William Gray, Colorado State University, September 1, 2006.
Managing Natural Catastrophes in a Post-9/11 World
The Broader Context:
Homeland Security
The Genesis of DHS
• In the wake of 9/11, President Bush issued the National
Strategy for Homeland Security in July 2002.
• Legislation creating the U.S. Department of Homeland
Security (DHS) was signed in November 2002.
• The creation of DHS represents a fusion of numerous
federal agencies, with the objective of coordinating and
centralizing the leadership of the nation’s homeland
security activities under a single, cabinet-level
department.
• Began operations in March 2003
• 22 separate agencies
• Approximately 180,000 employees
DHS: Historic Moment for the United States or Bureaucracy
Writ Large?
• The creation of DHS represents a historic moment of almost
unprecedented action by the federal government to transform how
the nation protects itself from acts of terrorism.
• Rarely in the nation’s history has such a large and complex
reorganization of government been attempted, with such a
singular and urgent purpose.
• DHS represents a unique opportunity to transform a disparate
group of agencies with multiple missions, values and cultures into
an effective cabinet-level department.
• A central aspect of DHS’s mission involves coordinating efforts to
protect critical infrastructure, prepare for possible attacks and
other emergencies, and respond to catastrophic incidents and
events.
• Accountability and performance thus far?
• Hurricane Katrina as a specific case in point – first real test of
the system
• DHS Inspector General
• U.S. GAO
• Academics and Think Tanks
Homeland Security: The Essential Tension
• Any coordinated and sustained effort to
effectively manage homeland security must
contend with two competing objectives/tasks:
• The prevention of terrorist acts
• Mitigation of consequences arising from acts of
terrorism and other extreme events
• In a difficult decision context like this, the
allocation of resources under what is, in
reality, deep and pervasive uncertainty is one
of the central challenges the federal
government faces in its efforts to manage
homeland security
The National Strategy for Homeland Security
• The National Strategy for Homeland Security describes
six critical missions areas:
• Intelligence and Warning
• Border and Transportation Security
• Domestic Counterterrorism
• Protecting Critical Infrastructure and Key Assets
• Defending Against Catastrophic Threats
• Emergency Preparedness and Response
• The President has also issued several additional
documents – called Homeland Security Presidential
Directives (HSPDs) – that provide more detailed
guidance on various homeland-security-related mission
areas and initiatives.
Emergency Preparedness and Response: Key Elements of
the National Strategy
Within the Emergency Preparedness and Response mission
area, the National Strategy identifies 12 separate initiatives:
1.
Integrate separate federal response plans into a single
all-discipline incident management plan
2.
Create a national incident management system
3.
Improve tactical counter terrorist capabilities
4.
Enable seamless communication among all responders
5.
Prepare health care providers for catastrophic
terrorism
6.
Augment America’s pharmaceutical and vaccine
stockpiles
Emergency Preparedness and Response: Key Elements of
the National Strategy (cont.)
7. Prepare for chemical, biological, radiological and
nuclear decontamination
8. Plan for military support to civil authorities
9. Build the Citizen Corps
10. Implement the First Responder initiative of the
FY03 budget
11. Build a national training and evaluation system
12. Enhance the victim support system
FEMA
Past, Present, and Future
DHS Organizational Structure: FEMA’s Place in the Larger Context
of Homeland Security
FEMA: Informed Opinion Prior to this Year’s Devastating
Hurricane Season
“…consolidate DHS response
missions into FEMA and strengthen
that agency. FEMA should be
engaged squarely in its traditional
role of planning for national (not
just federal) response to
emergencies….” [emphasis added]
DHS 2.0
Heritage
Foundation
December 2004
FEMA in the Wake of Hurricane Katrina
• FEMA has, of course, become
synonymous with the government’s
bungled response to the hurricane.
• To what extent is this a fair
characterization of this agency and
the difficult situation it now finds
itself in?
• Skepticism going forward…
FEMA: What Went Wrong and Why?
• Many theories and explanations have been
forthcoming
• Much of what is currently being said contains the
following core elements:
• The agency is no longer cabinet-level, but rather a small
cog within the organizational and bureaucratic behemoth
that is DHS
• FEMA’s mission to help states prepare for “all hazards” –
from terrorism to natural disasters – has become lost
within DHS’s myopic focus on terrorism.
• FEMA should perhaps revert to being an independent,
cabinet-level agency
The Centrality of the All-Hazards Context
HSPD 8 – National Preparedness: The National Planning Scenarios
• Developed under the leadership of the Homeland Security
Council
• Overarching goals are to
• Create the agility and flexibility to meet a wide range of
threats and hazards
• Provide a structure for the development of national
preparedness standards
• 15 planning scenarios provide parameters regarding the
nature, scale, and complexity of incidents of national
significance, which include both terrorism and natural
disasters.
• Each scenario provides a basis for defining prevention,
protection, response, and recovery tasks that need to be
performed, as well as required capabilities.
The National Planning Scenarios
The Homeland Security Council has developed 15 allhazard planning scenarios for use in national, federal,
state and local homeland security preparedness activities:
1.
Nuclear Detonation – 10-Kiloton Improvised Nuclear Device
2.
Biological Attack – Aerosol Attack
3.
Biological Disease Outbreak – Pandemic Influenza
4.
Biological Attack – Plague
5.
Chemical Attack – Blister Agent
6.
Chemical Attack – Toxic Industrial Chemicals
7.
Chemical Attack – Nerve Agent
The National Planning Scenarios (cont.)
8.
Chemical Attack – Chlorine Tank Explosion
9. Natural Disaster – Major Earthquake
10. Natural Disaster – Major Hurricane
11. Radiological Attack – Radiological Dispersal Devices
12. Explosives Attack – Bombing Using Improvised
Explosive Device
13. Biological Attack – Food Contamination
14. Biological Attack – Foreign Animal Disease (Foot and
Mouth Disease)
15. Cyber Attack
Scenario 10: Natural Disaster – A Major Hurricane
• In this scenario, a Category 5 hurricane hits a major metropolitan area
•
Sustained winds are at 160 mph, with a storm surge greater than 20 feet
above normal
•
As the storm moves closer to land, massive evacuations are required
•
Some low-lying escape routes are inundated by water anywhere from 5
hours before the eye of the hurricane reaches land
•Consequences associated with Scenario 10:
Casualties
1,000 fatalities; 5,000
hospitalizations
Infrastructure Damage
Buildings destroyed; large
debris
Evacuations/Displaced
Persons
1 million evacuated; 100,000
homes seriously damaged
Contamination
From hazardous materials, in
some areas
Economic Impact
Billions of dollars
Recovery Timeline
Months
Looking Towards the Future:
Where Do We Go from Here?
Challenges in Emergency Preparedness
Adopting an All-Hazards Approach
•
The National Strategy calls for the creation of
“a fully integrated national emergency response system that is
adaptable
enough to deal with any terrorist attach, no matter how
unlikely or
catastrophic,
as well as all manner of natural
disasters” [emphasis added]
•
Challenges:
•
Identifying the types of emergencies for which they should be prepared and
the requirements for responding effectively
•
Assessing current capabilities against those requirements
•
Developing and implementing effective, coordinated plans among multiple
first responder disciplines and jurisdictions
•
Defining the roles and responsibilities of federal, state, and local
governments and private entities
Challenges in Emergency Preparedness
Improving Intergovernmental Planning and
Coordination
• The National Strategy emphasizes a shared national
responsibility – involving all levels of government – in
responding to a serious emergency.
• In May 2004, GAO reported that a major challenge involves
what they saw as lack of coordination within DHS in terms
of the agency’s ability to prepare for, respond to, and
recover from terrorist and other emergency incidents:
“…there has been a lack of regional planning and coordination for
developing first responder preparedness, defining preparedness
goals, identifying spending priorities, and expending funds” (GAO04-433)
Challenges in Emergency Preparedness
Establishing Emergency Preparedness
Standards
• The National Strategy makes mention of
benchmarks, standards and other performance
measures for emergency preparedness.
• However, in January 2005, GAO found that
“…there is not yet a complete set of preparedness
standards for assessing first responder capacities,
identifying gaps in those
capacities, and
measuring progress in achieving performance
goals.” (GAO-05-33)
FEMA: The Story Thus Far
• Many are calling for Congress to restore FEMA to a
separate, independent agency.
• In Congressional testimony some months ago, DHS
Secretary Michael Chertoff acknowledged that Hurricane
Katrina “challenged the disaster relief system in a way that
has not ever happened.”
• He singled out planning as an area in need of improvement,
saying it was responsible for 80% of the failures.
• Secretary Chertoff pledged to retool FEMA:
• Improved aid delivery system
• Qualified senior leaders
• Modernizing business practices and communication systems
• However, Chertoff rejected the idea that FEMA should be
removed from under the DHS umbrella.
• Partisan politics reigns supreme?
“Why shouldn’t you be arrested for negligent homicide?”
Rep. Cynthia A. McKinney, D-GA
Source: Congressional Quarterly
Implications and Challenges for
P/C Insurers and Reinsurers
Mismanagement of Emergency Preparedness and Response Can
Impact the Economic Losses Associated with Natural Disasters
• Clearly, there is a relationship between “recovery time” and
the economic losses associated with a natural catastrophe
such as Hurricane Katrina
• Business interruption losses increase exponentially with
response lag
• Fires burn uncontrolled
• Failed law enforcement, rioting and looting
• Delayed flood drainage
• Untimely mitigation of environmental
release/contamination
• etc.
• While precise estimates of this relationship will require future
empirical study, a couple of points are worth considering in
light of Katrina:
• A key responsibility for P/C insurers is to play their
important and substantial role in the risk mitigation
process.
• It is important for federal, state and local officials to
understand and appreciate the role that insurance can play
in both minimizing loss and expediting recovery.
• Both P/C insurers and property owners, alike, have a
vested interested in seeing that the overall system works
as well as possible.
Challenges for P/C Insurers: Uncertainty of Losses
• Natural disasters pose vexing challenges for
insurers because they involve potentially high
losses that are characterized by large degrees of
uncertainty.
• Moreover, natural disasters involve spatially
correlated losses or the simultaneous occurrence
of many losses from a single event.
• Hurricane Katrina suggests a new “externality”
for P/C insurers to consider:
Mismanagement of the government’s
response and recovery efforts in the
affected region(s)
Rethinking Traditional Approaches to CAT Modeling and Risk
Management in Light of Katrina
• Traditional approaches to risk assessment and CAT
Modeling need to be revised to explicitly consider some
of these new “externalities” (e.g., political uncertainty,
etc.) into their overall analytical frameworks.
• A clear need for increased geo-spatial sophistication and
detail within CAT models, combined with the ability to
perform “cascaded inference” (broken levee  ּ ּ ּ 
evacuation of affected area).
• Seriously rethink the implications of changes in risk
appetite/tolerance and ambiguity aversion for risk
management strategies and corporate decision-making.
• Decision-Makers must become critical consumers of this
technology – not just passive receptors.
Summary Remarks
• The All-Hazards paradigm will become
central to the policy dialogue in the years
to come
• Policies and institutional regimes must be
flexible and responsive to the evolving
threat environment – both man-made and
natural
• TRIEA 05’ is an important component in
the country’s ability to confront and
manage extreme events
• Public/Private partnerships are essential
Second View:
Government as Ultimate Risk Manager
What Role Should the Federal Government
Play in Managing Extreme Events?
Components of the Second View
• Motivation
• The need for a public dialogue about natural disaster
risk
• The Protection of People and Property as a
Paramount Responsibility
• What Role Should the Federal Government Play?
• Potential Policy Responses: What Works and
What Doesn’t
• Concluding Remarks
The Need for a Public Dialogue About Natural Disaster Risk
•
The hurricane season of 2005 will surely be remembered for decades to
come — not just for the human and economic toll that it extracted on
those living in the Gulf Coast and Florida, but also for the profound
influence it will have in shaping the public dialogue in the U.S. about how
large-scale natural catastrophes should be managed in the post-9/11 era
•
This dialogue holds the promise of engendering substantive changes in the
interconnected web of social, political and economic systems that —
through a variety of formal and informal mechanisms — shift, spread, or
reduce the myriad risks that pervade life in the 21st century
•
This year’s hurricane season brought with it a degree of destruction and
devastation not seen in this country since the late 1920s
•
Moving forward:
•
How should we, from a societal perspective, shape our collective destiny in light
of what has tragically come to pass?
•
How might we do things better the next time around, taking into consideration
all of the attendant risks and complexities?
•
What role should the federal government play in managing natural disaster risk?
Fundamental Goal:
The Protection of People and Property
Top 10 Deadliest Hurricanes to Strike the US: 1851-2005
Hurricane Katrina was the
deadliest hurricane to strike the
US since 1928
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as
,T
LA
-S
W
ud
re
y
700
408
(1
85
6)
(1
95
7)
09
)
(1
9
Is
le
de
400
1,250
G
A
390
372
A
LA
-G
ra
n
8,000
*Could be as high as 12,000
**Could be as high as 3,000
***Midpoint of 1,000 – 2,000 range
****Associated Press total as of Dec 11, 2005 *****Midpoint of 1,100-1,400 range.
Sources: NOAA; Insurance Information Institute.
Global Number of Catastrophic Events, 1970–2005
The number of natural
and man-made
catastrophes has been
increasing on a global
scale for 20 years
250
200
Record 248 manmade CATs &
record 149 natural
CATs in 2005
150
100
50
Natural catastrophes
Man-made disasters
Man-made disasters: without road disasters. Source: Swiss Re, sigma No. 1/2005 and 2/2006.
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
0
Insured Property Catastrophe Losses as % Net Premiums Earned, 1983–2005E
16%
14%
12%
10%
US CAT losses were
a record 13.8% of
US
net premiums
Worldwide
earned in 2005 and
US average: 1984-2004 were 4.2 times the
1984-2004 average
of 3.3%
8%
6%
4%
2%
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05E
0%
*Insurance Information Institute figure of 13.8% for 2005 based estimated 2005 DPE of $417.7B and insured CAT losses of $57.7B.
Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute.
What Role Should the Federal Government Play?
Two Countervailing Viewpoints
•
In the vigorous public dialogue that has ensued in the wake of Hurricane
Katrina, two countervailing viewpoints have emerged concerning how
society should pay for mega-catastrophes
•
Each of these viewpoints proceeds from a particular vantage point and set
of beliefs about the role of government in managing and financing natural
catastrophe risk
•
On the one hand, there are those who believe that natural catastrophes
are fundamentally uninsurable and that the federal government should
serve as the ultimate risk manager in these instances
•
•
Key assumption: the federal government is in the best position to mitigate large
losses (economic and otherwise), in economically efficient ways
On the other hand, there are stakeholders in the debate that believe that
the private sector and the free-markets are in the best position to
adjudicate and manage these risks for those who choose to insure
privately
•
According to this view, the solution to the insurance dimension of this problem is
not more government involvement and regulation, but rather, less
•
Relaxing regulatory constraints and stringent tax policies will, they argue,
stimulate markets to craft creative solutions to the problem of “who pays?” for
mega-catastrophes.
Identifying Appropriate Federal Policy Responses
• In the coming years, these two opposing viewpoints will take
center stage in numerous public policy debates seeking workable
solutions to how we, as a country, move forward in light of the
difficult lessons of Hurricane Katrina
• For its part, the U.S. Congress is likely to consider a broad range
of proposals. For example:
•
Look for ways in which specific federal insurance programs like the
National Flood Insurance Program can be improved
•
Potentially sweeping changes in how the nation deals (both ex ante
and ex post) with mega-catastrophes, both natural and man-made
• While it is early to speculate as to what this process will yield by
way of specific mandates, statutes and potential reorganizations
of government, it is clear that change will be an inevitable feature
of the institutional arrangements, mechanisms and conceptual
schemes that have traditionally governed our thinking about how
disaster policy should be formulated and implemented in this
country
The Case For a Federal Natural Catastrophe Program
• Arguments in favor of a substantive federal role in the
financing of natural disaster risk almost invariably proceed
from a rather basic premise:
some risks are simply too large or unpredictable to be
insurable within the current institutional, financial and
regulatory frameworks that govern private insurance
markets in this country
• At the heart of these debates is the view that megacatastrophes may soon exceed the ability and capacity of
private insurance markets to deal effectively with incidents
of this magnitude
• In the wake of Hurricane Katrina, some insurers and other
relevant stakeholders are openly questioning whether
natural catastrophes of this magnitude are insurable via the
private markets
Policy Proposals: Towards a Comprehensive NAT CAT Plan
• Most of the proposals envisage a three-layer plan:
1. Policies sold by individual insurance companies
2. State or regional catastrophe pools that provide reinsurance
3. A national mega-catastrophe fund that provides a federal backstop for
large-scale insured losses
• For its part, the U.S. House of Representatives has introduced two
bills, the Homeowners Insurance Availability Act of 2005
(H.R.846) and the Homeowners Insurance Protection Act of 2005
(H.R. 4366), both of which would create federal catastrophe
reinsurance programs
•
Under H.R. 846, the Treasury would auction so-called excess-of-loss
reinsurance contracts—a type of reinsurance that provides coverage
above specified levels of loss
•
Under H.R. 4366 the Treasury would be authorized to sell reinsurance
contracts directly to eligible state catastrophe funds
NAIC’s Comprehensive National Catastrophe Plan
• Proposes Layered Approach to Risk
• Layer 1: Maximize resources of private insurance & reinsurance
industry
• Includes “All Perils” Policy
• Encourage Mitigation
• Create Meaningful, Forward-Looking Reserves
• Layer 2: Establishes system of state catastrophe funds (like the
Florida Hurricane CAT Fund)
• Layer 3: Federal Catastrophe Reinsurance Mechanism
Source: Insurance Information Institute
Objectives of NAIC’s Comprehensive National Catastrophe Plan
• Should Promote Personal Responsibility
Among Policyholders
• Supports Reasonable Building Codes,
Development Plans, and Other Mitigation Tools
• Maximize the Risk Bearing Capacity of the
Private Markets
• Should Provide Quantifiable Risk Management
to the Federal Government
Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.
Existing Federal Insurance Programs
• Another reason that is often cited for expanding and enhancing
the role of the federal government in financing natural
catastrophe risk is that the federal government is, of course,
already involved in numerous federal insurance programs, two of
which deal specifically with natural disasters:
•
The Federal Crop Insurance Program
•
The National Flood Insurance Program
• These two programs are subsidized by the terms stipulated in
their authorizing statutes and, at present, participation in the
programs is voluntary
• Programs such as these are often criticized for the inherent
difficulties in assessing the government’s true risk exposure and in
setting premiums commensurate with that exposure
• Moreover, organizations such as the National Association of
Insurance Commissioners have argued that requiring homeowners
to purchase multiple insurance contracts to protect their property
is both cumbersome and inefficient
Complicating Factors Going Forward
•
Going forward, regulatory constraints may not allow insurers to charge
actuarially sound rates that reflect the increased levels of risk
•
Moreover, the price and availability of private reinsurance is volatile
•
For these and a host of other reasons, the 2005 hurricane season has
given risk managers within the property/casualty insurance and
reinsurance industries much to consider
•
For example, with many of the exposure predictions and projected loss estimates
made prior to this year’s hurricane season proving, in hindsight, to be grossly in
error, catastrophe models have come under considerable criticism and scrutiny
•
Many insurers and reinsurers are openly questioning their confidence in these
models. As one exasperated insurance CEO recently exclaimed, “They just don’t
know what they’re talking about; they say these events are 1-in-100, 1-in-250,
1-in-1000, or maybe it’s 1-in-1,000,000, but they have no idea”
•
Many within the industry fear that the risk assessment component of the
insurance underwriting process may grow increasingly complex and
unmanageable, as the coming decades may be marked by hurricane
activity levels that well exceed recent historical baselines
•
Difficult questions and complex scientific debates concerning the manner
and degree to which global climate change is responsible for these
emerging weather patterns will surely complicate matters even further
The Case Against a Federal Natural Catastrophe Program
• Most of the reticence on the part of insurers to back the idea of a
federal backstop for large natural catastrophes stems, at a basic
level, from a firmly-rooted laissez-faire mindset as to how
insurance markets should operate in the global economy
• They believe that increased federal involvement and regulatory
authority in these markets is something to be avoided, because
such actions hold the potential to, in effect, crowd out private
insurance and reinsurance markets, and to stifle innovation within
these markets
• In this context, it is often argued that the relationship between
price and risk assumed is diminished, as federal insurance
programs are rarely actuarially sound
• With regard, then, to natural catastrophe risk, the fundamental
belief is that this class of risk is, indeed, insurable in the free
markets
Does the Evidence Support the Free Market View?
• Perhaps the truest measure of the veracity of this claim is
that the free markets have, thus far, performed well under
especially trying conditions
• The global insurance industry has experienced
unprecedented disasters over the past four years:
• The tragedy of September 11th, at that time the most
significant insurance catastrophe in history
• Record tornadoes and wildfires in 2003
• Four major hurricanes in Florida in 2004
• Hurricane Katrina will cost the insurance industry in excess
of $40 billion, according to estimates by ISO’s Property
Claims Services, but more of the cost will be borne by
reinsurers than in previous years
Insurance Industry Resilience
• Wall Street analysts expect the insurance industry to be able to
pay Katrina claims without any significant weakening of its overall
financial strength
• Standard & Poor’s has stated that, for most of the companies that
the ratings agency follows, Katrina will depress earnings for
several years
• Catastrophe reinsurers will be the most severely impacted
segment of the industry, and prices for property catastrophe
reinsurance will likely increase significantly due to heightened
expectations concerning the frequency and severity of natural
disasters worldwide
• Clearly, the industry has responded well during this
unprecedented period, demonstrating both its financial resilience
and its commitment to individual and corporate customers
Potential Policy Responses:
What Works and What Doesn’t
Successful Tools for Controlling Hurricane Risk Exposure
• Strengthened building codes
• Stringent enforcement of building codes
• Fortified home programs
• Insurance rates based on sound actuarial principles (rates that
are not government controlled); Works for commercial insurers
• Limits on underwriting
• Removing impediments to capital flows
• Incentives to adopt mitigation
• Forcing communities to consider their own catastrophe exposure
Source: Insurance Information Institute
Unsuccessful Tools for Controlling Hurricane Exposure
• Insurance rates that aren’t actuarially sound
• Political interference in rate process
• Inadequate underwriting controls
• Subsidies
• Intra-state (policyholders/taxpayers)
• US Taxpayer
• Litigation
• Retroactive rewriting of insurance contracts
• Low flood insurance penetration rates
Source: Insurance Information Institute
Problematic Issues
• Local control of land use and permitting creates
significant incentive problems
• Benefits accrue locally while many costs can be redistributed
to others via taxes, insurance, insurance assessments and aid
• Prospect of government aid reinforces unsound
building and location decisions
• States don’t want to raise taxes to pay for
mitigation/prevention even if state is sole beneficiary
• E.g., NO levees; Beach replenishment
Source: Insurance Information Institute
Recommendations for Controlling Hurricane Exposure
• Raise public awareness of risk
•
Mandatory risk disclosure in all residential real estate transactions
•
Require signed waivers if decline flood coverage that also waive rights to any
and all disaster aid
• Continue to strengthen and enforce of building codes
• Allow markets to determine all property insurance rates
• Increase incentives to mitigate
• Require state-run insurer and reinsurer to charge actuarially sound rates
•
Limit state-run insurer exposure to high-value properties
• Require communities/counties to a financial stake in their catastrophe
exposure
•
Reimburse disaster aid to state/federal government
Concluding Remarks: Moving Beyond the Potential Impasse
•
Regardless of where specific industry stakeholders stand on the continuum of
viewpoints outlined above, there are areas where they may find some basis for
agreement and common ground
•
Most stakeholders will agree, for example, that a key responsibility for P/C insurers is to play
their important and substantial role in the overall risk mitigation process
•
In the case of large-scale natural disasters, it is important for federal, state and local officials
to understand and appreciate the role that insurance plays in both minimizing loss and
expediting recovery
•
In order to move beyond the potential impasse in which the industry could find itself
with regard to these issues, what is needed is an earnest attempt on the part of the
public and private spheres to look for areas where government can facilitate marketenhancing opportunities and more efficient private-sector coordination
•
Practical proposals to this end will include such activities as the encouragement of
various loss mitigation strategies, including strong building codes and improved landuse planning
•
Going forward, the challenge remains one of finding workable means and
mechanisms by which to align incentives in ways that jointly enhance social welfare
and the market
The two activities do not necessarily need to be viewed
as being mutually exclusive
INSURANCE INFORMATION INSTITUTE ON-LINE
www.iii.org
Dr L James Valverde, Jr
Vice President
Economics and Risk Management
Insurance Information Institute
110 William Street
New York, NY 10038
Tel: (212) 346-5522
Fax: (212) 732-1916
jamesv@iii.org www.iii.org
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