Natural catastrophes: What's next, and who will pay?

The first concern is the sheer magnitude of events bigger than models had predicted, and the second concern is the secondary damage caused by factors such as tsunamis, liquefactions and the like.

Such an example has been seen in the 2011 Tohoku-Oki earthquake (used by catastrophe modeling firm, AIR Worldwide), where the magnitude of the event significantly changed the risk landscape for severe events in Japan from 72% to 81% and 93%.

 

Although the earthquake helped to release a lot of pressure, the fact remains that it also dispersed to other regions, increasing the risk of those areas.

 

Dr Jayanta Guin, senior vice president for research and modeling at AIR Worldwide, said that an earthquake of Tohoku-Oki’s magnitude had not been recorded in Japan in 1000 years. This prompted him to search for (and finding) evidence of similarly large events in other earthquake prone zones.

 

Clarence Wong, Asia chief economist for reinsurer Swiss Re, added that what happened after this earthquake was an eye-opener. "We saw liquefaction in Tohoku-Oki and New Zealand. Then, we had the tsunami, and business interruption was grouped in as a secondary agent.”

Munich Re, one of the world’s largest reinsurers, took the current spate of catastrophic events to the next level of chaos theory modeling, by better reserving for such events, and driving the change of current modeling to provide for greater CBI (Contingent Business Interruption) loss post-catastrophe events.

AIR Worldwide found the Tohoku-Oki tsunami, which reached a height of over 30 meters, was responsible for as much as 30% of losses. This brings us to another challenge facing modeling firms today, namely, predicting how big the actual waves will be, and in what direction will they travel. This is, however, expensive to determine and not necessarily worth your while.

 

Tohoku-Oki highlighted the limitations of the models. It does not mean that current models are ineffective, it means that models are only as good as the data they rely on, and that models need to be supplemented with a holistic approach to risk, requiring insurers to go through the exercise of thoroughly analysing and predicting worst-case scenarios.

Japanese modeling falls surprisingly short. Japanese insurers had paid out so much in claims to date; they now need ten years of no-claims to build up their reserves. Their government is still picking up liabilities out of current spending, as they did not have a fund set aside to fulfill a re-insurance role.

The insurance industry is also looking at the claims handling process. In Japan, a government-backed scheme, which brought insurers into a state-re-insured pool, meant that claims were handled in a quick manner. Working together, insurers sent thousands of staff to deal with the problem at hand. As such, this model is now being adopted by countries plagued by frequent catastrophic events.

 

Currently, major catastrophe insurers believe that the industry can work with governments, particularly those in emerging markets, on an improved model with knock-on advantages, including higher insurance penetration, which presents insurers with greater opportunities.

Reinsurers are also doing well by means of renewals. They are pushing for price rises, because having paid out, they need cash, but where the full rise is unobtainable, they have restricted cover and cut commissions.

Having said that, and in light of the fact that 20 of the 30 most costly insured catastrophes worldwide from 1970 to 2011 have occurred since 2001, and all of them were natural disasters except for the 9/11 terrorist attacks, the question on everyone’s lips is, "What’s next, and who will pay ..?”

In the meantime, the effects of climate change, and the number of people and valuable properties located in high-risk areas, continue to rise…