Managing Catastrophes through Insurance: Challenges and Opportunities for Reducing Future Risks

A New Era of Catastrophes. A series of large-scale catastrophes have occurred in the United States during the first decade of the 21st century that has overshadowed previous years. Fourteen of the twentyfive most costly insured catastrophes in the world since 1970 occurred during the past eight years, thirteen in the U.S. With respect to natural disasters our country has entered a new era of catastrophes and the coming years are likely to be even more devastating. Property values at risk in hazard-prone areas have increased significantly due to population growth and increased value at risk. For example, the population of Florida has increased from 2.8 million in 1950 to a projected 19.3 million in 2010 – almost a sevenfold increase. Some believe that global warming might lead to much more intense hurricanes hitting the coast over a shorter period of time. Who Should Pay for Future Losses? A key question that needs to be addressed is: Who should pay for the cost of future disasters? In some states, there is increasing tension between insurers and state regulators: insurers would like to charge risk-and-cost of capital-based premiums while state regulators or policymakers require that premiums be set artificially low to encourage economic development in their state and to address affordability issues for those currently residing in hazard-prone areas. Impact of Current Insurance Programs. In many states due to regulatory restriction, private insurers cannot provide pricing signals to residents in hazard-prone areas as to the risks they face and this may cause them to have a false sense of security. There may be short-term rewards to elected officials if mega disasters do not occur in their term of office. In the long run, however, a policy of artificially low rates discourages individuals from adopting cost-effective risk reduction measures and hence increasing our exposure to large-scale disasters. When these catastrophes occur, disaster assistance is often provided to those who suffer losses and who are not adequately protected. Even with this relief many of these victims will not fully recover from the disaster. The Need for Leadership and Innovative Programs. Given divergent agendas between insurers and states insurance regulators, the prices insurers are permitted to charge in some states may lead them to significantly reduce their coverage and in some cases refuse to write new coverage in hazard-prone areas or even consider or take steps to leave the state completely as illustrated by State Farm’s stated intention to leave Florida by 2011. The insurance industry has an opportunity to take a leadership role in proposing new approaches for significantly reducing exposure to future natural disasters while at the same time providing funds to aid victims in their recovery process and assure an adequate return to shareholders. By adhering to a set of guiding principles and working closely with other interested parties in the private and public sectors there is an opportunity to reduce property exposure so as to reduce future losses by billions of dollars from what it would otherwise be.