The Coming Storms
By Shaun Wang
On a sunny day in the fall of 2008, the natural surroundings of my Atlanta home were so tranquil and beautiful that it made me forget for a moment all the financial market turmoil that was going on.
Fast forward to early 2011. The U.S. economy now appears to be on a gradual recovery, especially if you look at the impressive run up of the stock markets. Suddenly on March 11, 2011, a devastating earthquake and tsunami hit Japan. The horrific scenes of natural disaster and human tragedy made my stomach wrench.
Now, looking ahead to the coming years, I sense an impending storm gathering. It is likely a perfect storm, combining natural disasters on a larger scale than the Japan earthquake and a second-dip market meltdown worse than the fall 2008 financial crisis.
The clouds for the coming storm are visible:
- Four of the five costliest earthquakes and tsunamis of the last 30 years have occurred in the last 13 months. There is a geophysical linkage (via crustal plates) of Chile, New Zealand, Japan, and the Northwest U.S. as the Pacific “Ring of Fire.” Given the recent earthquakes in Haiti (January 12, 2010), Chile (February 27, 2010), New Zealand (September 4, 2010, and February 21, 2011), and Japan (March 11, 2011), the conditional probability of an earthquake within the next year in the northwest U.S. has increased significantly due to the changing pressures on the crustal plates.1,2
- The world is on a brink of severe shortage of food and water, due to growing demand that supplies cannot keep up with. The world population has reached a new peak of nearly seven billion. The population growth rate is faster than exponential growth, given that the one billion mark was first reached around the year 1800. This population growth coincides with industrial consumptions for agricultural and water resources. Meanwhile the earth is facing the prospect of severe drought in the arable land areas (despite the floods in Australia)3. Severe drought and water scarcity will affect the food availability and cause spikes in food prices.
- There are other potential threats of natural and man-made disasters. NASA warns that solar flares from a “huge space storm” might cause devastation. Solar flares would be like “a bolt of lightning” and may cause disruptions to the communication and navigation systems. AR readers may have seen the profile of Nolan Asch’s nonactuarial pursuits in the February issue (“Saving the World from Asteroids”). These may be less likely than the ring of fire earthquake scenarios, but nevertheless represent possible systemic threats.
- Risk managers should be concerned with a set of perfect storm scenarios triggered by natural disasters such as massive earthquakes or volcanic eruptions in the U.S. (or less likely, solar flares), combined with a scorching sun with severe drought, food shortage, and disruptions to the wireless communications and network connections. When such a disruption occurs, it will almost certainly trigger a market meltdown. The fragile U.S. economy would not be able to sustain such a shock, and the government has run out of means and tools to deal with one.
Natural disaster-triggered market meltdown presents a systemic threat to the U.S. economy and the insurance industry. Insurance companies should first assess and evaluate the potential insured losses from specific natural disaster scenarios and associated investment portfolio losses from the market meltdown, with anticipation of demand surge and supply shortage that can dramatically increase the costs of insurance claims. After risk assessment, insurance companies should seek to diversify the extreme tail risks through global reinsurance, hedging, and catastrophe bonds.
For pre-event risk management, insurers can encourage disaster preparedness by offering premium discounts and rebates through a post card checklist for policyholders who certify that they have a certain set of disaster preparedness items in their homes and business sites. A concerted insurance industry-sponsored effort to encourage individual disaster preparation could also involve a nonprofit organization for disseminating preparedness information pre-event and coordinating response post-event. This nonprofit organization could be authorized to acquire tangible assets (shelters, water, food, medical supplies) and contingent plan logistics (with trained back-up personnel and equipment, which can operate when existing communication and transportation are shut down). Pre-event risk management can get more bang for the buck; it helps society and saves lives in a time of major disruption.
At the individual level, I think we should also practice pre-event risk management by stock piling enough water, non-perishable food, and back-up electrical generators to last for 2-4 weeks. Local communities should coordinate and unite in the preparedness.
Winston Churchill once said, “The pessimist sees difficulty in every opportunity. The optimist sees opportunity in every difficulty.” By being prepared, we can find the path that leads to calm water in the midst of storm, and we can seize the opportunities to help others in need.
Dr. Shaun Wang, FCAS, is the founder and chairman of Risk Lighthouse LLC. He can be contacted at email@example.com.