Need to Manage Risk

The problem of preparing for a natural disaster is not a new one.
Around the world and particularly in the more-developed countries,
governments, individuals and corporations know they should prepare for a
“big earthquake” or a “large hurricane” or an “extensive flood.” Yet, they
often do not take the necessary steps to prepare for a disaster. Only after a
disaster occurs do they recognize the importance of preparing for these types
of extreme events.
A major earthquake or hurricane can result in loss of life and serious
damage to buildings and their contents. Bridges and roads can be damaged
and closed for repair over long periods of time. Disaster victims may need to
be relocated to temporary shelters or reside with friends or relatives for days
or weeks. Businesses may have their activities interrupted due to facility
damage or lack of utility service. For some businesses, this may result in
insolvency. In August and September 2004, these challenges were obvious
when Florida and other states as far north as New Jersey and Pennsylvania
were deluged by Hurricanes Charley, Frances, Ivan, and Jeanne.
The need to prepare for these types of extreme events is evident when
evaluating the economic consequences of natural disasters.
A great natural catastrophe is defined as one
where the affected region is “distinctly overtaxed, making interregional or
international assistance necessary. This is usually the case when thousands of
people are killed, hundreds of thousands are made homeless, or when a
country suffers substantial economic losses, depending on the economic
circumstances generally prevailing in that country”
the amplitude of the
peaks seems to be increasing over time. This trend is expected to continue as
higher concentrations of population and built environment develop in areas
susceptible to natural hazards worldwide. Additionally, worldwide losses
during the 1990’s exceeded $40 billion dollars each year with the exception of
1997. Losses were as high as $170 billion in 1995, primarily due to the largescale
earthquake that destroyed portions of Kobe in Japan in January of that
year. Insured losses matched this growth during the same timeframe.
The volatility and trend in losses can be seen in the United States as
well.
U.S. catastrophes are deemed significant when
there is an adjusted economic loss of at least $1 billion and/or over 50 deaths
attributed to the event (American Re, 2002).
There are peaks in losses due to catastrophic events, as in worldwide
losses (most prominently in 1989, 1992, and 1994), and the upward trend over
the past 50 years is evident when broken down by decade,
. The losses from individual disasters during the past 15 years are an
order of magnitude above what they were over the previous 35 years.
Furthermore, prior to Hurricane Hugo in 1989, the insurance industry in the
United States had never suffered a loss of over $1 billion from a single
disaster. Since 1989, numerous disasters have exceeded $1 billion in insured
losses. Hurricane Andrew devastated the coastal areas of southern Florida in
August 1992, as well as damaging parts of south-central Louisiana causing
$15.5 billion in insured losses. Similarly, on the west coast of the United
States, insured losses from the Northridge earthquake of January 1994
amounted to $12.5 billion.
Residential and commercial development along coastlines and areas
with high seismic hazard indicate that the potential for large insured losses in
the future is substantial. The ten largest insured property losses in the United
States, including the loss from 9/11, The increasing trend for
catastrophe losses over the last two decades provides compelling evidence for
the need to manage risks both on a national, as well as on a global scale.


Private Sector Stakeholders in the Management of Risk
The magnitude of economic and insured losses from natural disasters
raises various questions. Who are the individuals affected by these events?
What options are available to them to assess their risk? What factors influence
their choices for dealing with these risks and actively managing their risk? By
examining the perspectives of these individuals and groups, one can develop
more effective risk management strategies for reducing potential losses from
such disasters.
Each of the stakeholders’ goals and perceptions of the risk lead them to view natural hazards from a unique perspective.At the bottom of the pyramid are the property owners who are the
primary victims of losses from natural disasters. They have to bear the brunt
of the losses unless they take steps to protect themselves by mitigating or
transferring some of the risk. Insurers form the next layer of the pyramid.
They offer coverage to property owners against losses from natural disasters.
Insurers themselves are concerned with the possibility of large claim
payments from a catastrophe and turn to reinsurers, the next layer of the
pyramid, to transfer some of their risk. At the top of the pyramid are the
capital markets, which in recent years have provided financial protection to
both insurers and reinsurers through financial instruments, such as catastrophe
bonds. Of course, there are exceptions to this pyramid structure. For example,
there have been two catastrophe bond issues (Concentric Re, covering Tokyo
Disneyland, and Studio Re, covering Universal Studios) that offered direct
protection to these property owners in place of traditional insurance
arrangements.