Japanese earthquake: The insurance world “shaken” to the core

As the Japanese nation struggles to come to terms with the human and economic impact of the quake/tsunami/nuclear catastrophe, economists and insurers are crunching a different set of numbers.

On 11 March 2011 a magnitude 9.0 earthquake struck 140 kilometres east of Japan. In the hours that followed a 10-metre high tsunami ripped into the Japanese coast line, laying waste to human life, property and infrastructure – and triggering a partial meltdown at the country’s Fukushima nuclear power plant. A month later, economists and insurers are still struggling to put a dollar value to the catastrophe.

The Japanese quake/tsunami/nuclear catastrophe has claimed more than 11 000 lives and left half a million Japanese civilians homeless. Photographs and video footage of the catastrophe aftermath has affected each and every one of us. The sheer scale of the destruction has been beamed directly into our living rooms!

Estimating the cost

Economists have been stumped by the likely impact of the quake on the Japanese economy and their initial estimate for direct and indirect damages, set at $1 trillion, appears little more than a thumb suck. Clearly they’re dealing with a different animal to the 1995 Kobe quake which caused $100 billion in damages. The Bank of Japan entered the affray almost immediately, injecting $180 billion in short-term liquidity to prevent a collapse of its financial system.

In the days following the quake, Boston-based risk modelling agency AIR Worldwide said the quake alone caused insured property losses totalling $15 billion to $35 billion. The group’s estimate includes “insured shake and fire-following damage to onshore residential and commercial buildings and contents, and to properties in agricultural line of business”. But it has yet to estimate the tsunami-related damage. The reality is the damage caused by the subsequent tidal wave could be much greater – perhaps even eclipsing the $71 billion insurance price tag of Hurricane Katrina, which tore into New Orleans in 2005.

Insurers’ expectations

Individual insurers have started making their estimates too. “As part of our market oversight we have a realistic disaster scenario which looks at a $64 billion earthquake centred on Tokyo,” says Lloyds of London finance chief, Luke Savage. “We think that this loss will come well within that.”

Meanwhile Fuji Fire & Marine Insurance, a subsidiary of US-based AIG, faces a maximum of $508 million in claims through the Japanese Earthquake Reinsurance (JERC) fund. The impact on Fuji Fire isn’t too severe thanks to the group’s large earthquake disaster reserves, but AIG has additional exposure to quake and tsunami damage totalling $700 million.

Reinsurers hardest hit

Reinsurers have been hardest hit by the catastrophe. Global reinsurance giant Munich Re announced recently that it will have to pay out around $2.1 billion for claims resulting from the quake and tsunami, Swiss Re expects a $1.2 billion claims bill, and Hannover Re has pencilled in $350 million.

How safe are we?

Compared to the Japan catastrophe, local insurers have enjoyed a benign start to 2011. The flooding and resultant damage to property experienced along the banks of the Vaal and Orange rivers pales in comparison to the total loss events in Australian (flooding), Christchurch (earthquake) and Japan. This doesn’t mean local insurers can assume the country is insulated from the earthquake threat.

“The memory of an extreme natural disaster lasts for only one generation,” says Christelle Fourie, Managing Director at MUA Insurance Acceptance. “Because the last disastrous natural earthquake in South Africa occurred four decades ago, it becomes easier for us to behave as if we are immune to the possibility of being hit again.” A leading Johannesburg-based insurance broker puts the risk of a significant earthquake in South Africa at two on a scale of zero to 10, compared with a risk from fires, storms and flooding of around eight. He says when an earthquake happens it will be a “total disaster” – but points out that the likelihood rolls around only every 100 to 250 years.

South Africa’s seismic risk

Professor Andrzej Kijko, director of the Aon-Benfield Natural Hazard Centre at the University of Pretoria, says South Africa is lucky because strong seismic events tend to be separated by a couple of hundred years. “But remember once it happens, it will happen again,” he says. “It’s just that people don’t remember. Look at Haiti [the country suffered a catastrophic magnitude 7.0 earthquake on 12 January 2010] where people started rebuilding the very nextday.”

Kijko co-authored the first detailed investigation to assess South Africa’s seismic risk as applied to the insurance industry in 2003. His report found that seismic risk in Cape Town, Johannesburg and Durban was “not a negligible component” of property rating. In Cape Town, up to 80 percent of all structures could experience light damage and another 10 percent moderate damage post-quake.

Managing the risk

But major local insurers such as Santam, Mutual & Federal and Auto & General aren’t overly concerned with potential losses due to quake thanks to the catastrophe insurance policies they place with reinsurers. Randolph Moses, managing director of reinsurer Hanover Re Africa, says South African insurers and reinsurers calculate their catastrophe exposure and probable maximum loss in respect of earthquakes and other perils, but cautions that capturing the correct data and creating actuarial models remains a challenge.

“It’s quite a complex subject because not only does it require actuarial modelling, but also other specialities, like geosciences,” he says. “And it’s still unclear to what extent all insurers update their models regularly to take account of factors like urban sprawl.” A similar situation exists at many popular holiday destinations along the Garden Route. As holidaymakers build luxury seaside getaways they significantly “bump up” the value of infrastructure in areas prone to flooding.

Local hot spots

Could we expect a major quake to rip through one of our commercial centres? Seismology experts say South Africa’s potential for earthquake damage comes in the form of natural seismic activity, mining-related events from deep underground mining, and earthquakes that occur outside our borders but are nevertheless strong enough to create some kind of effect. We’ve certainly felt the occasional mining-related tremor in Johannesburg, Pretoria and surrounds.

Things are more serious for inhabitants of Cape Town. Moses observes: “The Milnerton fault is an area we are aware of!” The fault line starts about eight kilometres offshore of the Koeberg nuclear station before cutting southeast through Milnerton and across the Cape Flats. This fault has triggered two major seismic events – the first in 1620 near Robben Island (estimated at around magnitude 4.0), and the second in December 1809 (of magnitude 6.1).

Ready or not?

Improvements in seismic monitoring make it possible for insurers and reinsurers to build complex models to estimate their exposure in the event an earthquake occurs. Via a series of complex overlays, they can translate the likely geographic location and strength of any potential event into potential damage to buildings and monetary losses. “For example, if we know that a building costs R1 million and say 5% might be destroyed by a magnitude 4.0 quake, then we estimate expected losses of R50 000,” Kijko says. “This is the starting point for the insurance industry.”

Fourie concludes: “The industry is certainly aware of earthquake risk and has factored it into premiums for insured risks. But it might take a large seismic event to test just how seriously it is rising to the challenge.”