Reducing Losses from Catastrophic Risks through Long-Term Insurance and Mitigation

Howard Kunreuther Reducing Losses from Catastrophic Risks through Long-Term Insurance and Mitigation RECENT CHANGES IN THE IMPACTS OF EXTREME EVENTS Increases in Economic and Insured Losses The econom ic and in su red losses from n atu ra l disasters have increased significantly in recent years, as shown in figure 1 (each verti­ cal bar represents the total economic losses, the darker zone repre­ sents the insured portion of it).' A comparison of these economic losses over tim e reveals a huge increase: $53.6 billion (1950-59), $93.3 billion (1960-69), $161.7 billion (1970-79), $262.9 billion (1980-89), and $778.3 billion (1990-99). The current decade has already seen $420.6 billion in losses, principally due to the 2004 and 2005 hurricane seasons, which produced historic records. Catastrophes have had a m ore devastating im pact on insurers over the past 15 years than in the entire histoiy of insurance. Between 1970 and the mid-1980s, annual insured losses from natural disasters (including forest fires) were in the $3 billion to $4 billion range. The insured losses from Hurricane Hugo that made landfall in Charleston, South Carolina on Septem ber 22, 1989 exceeded $4 billion (in 1989 prices). It was the first natural disaster to inflict m ore than $1 billion of insured losses in the United States. There was a radical increase in insured losses in the early 1990s w ith Hurricane Andrew (1992) in social research Vol 75 : No 3 : Fall 2 008 905 Figure 1. Evolution of “Great Natural Catastrophes” Worldwide, 1950-2007: Economie Versus Insured Impact Great natural disasters 1950 ± 2007 Overall and Insured losses 200 180 160 140 120 100 -aLj-d 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 i i overall losses Insured losses (2007 values) (2007 values) .............. Trend overall losses ------------ Trend insured losses Sources: Data from Munich Re; 2008 Geo Risks Research. In billions of US dollars, indexed to 2007. Florida ($23.7 billion in 2007 dollars) and the Northridge earthquake (1994) in California ($19.6 billion in 2007 dollars). The four hurricanes in Florida in 2004 (Charley, Frances, Ivan, and Jeanne) taken together cost insurers alm ost $33 billion. Insured and reinsured losses from Hurricane Katrina, which made landfall in the United States in August 2005, are now estim ated at $46 billion; total losses paid by private insurers due to m ajor natural catastrophes were $87 billion in 2005. Figure 2 depicts the upw ard trend in worldwide insured losses from catastrophes between 1970 and 2007 (in 2007 indexed prices; corrected for inflation). Table 1 reveals the 20 most costly catastrophes for the insurance sector since 1970 (in 2007 dollars). Several observations are relevant here. First, 18 of the 20 m ost costly events have occurred since 1990. Hurricane Andrew and the Northridge earthquake were the first two 906 social research Figure 2. Worldwide Evolution of Catastrophe Insured Losses, 1970-2007 Note: For 9/11, all lines, including property and business interruption (BI). All figures are in billions of US dollars, indexed to 2007. Source:Wharton Risk Center, with data from Swiss Re and Insurance Information Institute. disasters th a t th e in d u stry ex p erie n c ed w h ere lo sses w ere greater th a n $10 b illio n (d esig n a ted as “su p er-cats”) and cau sed in su rers to reflect o n w h e th e r risk s fro m n a tu ra l d isa sters w ere in su ra b le. To a ssist th e m in m a k in g th is d ete r m in a tio n , m a n y firm s b eg a n u sin g ca ta s­ tro p h e m o d els to estim a te th e lik e lih o o d an d co n se q u e n c e s to th eir in su red p ortfolios from sp ecific d isasters in hazard-prone areas (G rossi and K unreuther, 2005). W ith th...