Catastrophes Disasters and Insurance, Oh My!

The wrath of Mother Nature has always been a real concern, but lately it seems as though she has been especially scornful. A recent article by Patricia-Anne Tom was published in the Insurance Journal that discusses this issue and how it affects all of us. Dr. Erwann Michel-Kerjan is the managing director of the Wharton Risk Management and Decisions Processes Center in Pennsylvania, and in the article he explains the drastic increase in the number of catastrophes and the way they impact an ever-increasingly interconnected world.

Dr. Erwann Michel-Kerjan uses the first decade of the 21st Century as proof of the increasing frequency of man-made and natural disasters. Catastrophes include the Sept. 11th terrorist attacks, the anthrax crisis, SARS, blackouts on the East Coast, the Indian Ocean Tsunami in 2004, various terrorist attacks across the pond in the UK, Hurricanes Wilma, Rita, and Katrina, the 2008 earthquake in China and the cyclone that hit Myanmar around the same time, the global financial crises, the earthquakes that shook Haiti and Chile, the BP oil spill on the Gulf Coast, Japan’s myriad of misfortune including the earthquake, tsunami, and nuclear reactor meltdown and most recently, the rampant flooding and tornadoes across the US. All of this has happened in less than ten years time.

Dr. Michel-Kerjan said “There has not been a six-month period in the past few years without a major crisis that simultaneously affected several countries or industry sectors.”

So what does this mean to the average policyholder? According to Dr. Michele-Kerjan it means that we have to realize that premiums are going to have to increase to account for these catastrophes and the frequency in which they occur. Insurance companies have to account for the extra money they dish out for claims, and that equates to higher insurance premiums. It may be a bitter pill to swallow, but there is no other choice.

Dr. Michel-Kerjan advises that conventional thinking in regards to disasters must change. They are no longer an issue for a given country or area, but rather an issue for many countries, economies, etc. Due to the fact that the world’s economies are so intertwined, a catastrophe in Japan, for example, can and will affect the US, and vice versa. In order to better prepare for these catastrophes, Dr. Michel-Kerjan suggests a “new risk architecture” that frames the way societies plan for and manage these unforeseen catastrophes.

So, you ask, what does this mean for the insurance industry? Well, according to the good Dr., it means the insurance industry must re-evaluate how they assess risks. He describes the current model as looking at issues in a “silo” in which the interconnectedness of the world and how it relates to risk assessment is not considered. The shift must occur in the way these risks are assessed to account for our interconnectedness.

Patricia, the author of the article, uses the National Flood Insurance Program (NFIP) as an example of an entity starting to work in that direction.

Dr. Michele-Kerjan said, “The NFIP was put in place more than 40 years ago and now covers more than $1.2 trillion in assets and is one of the largest federal disaster programs in the world.”

Dr. Michel-Kerjan stated in the article that his company recently evaluated the NFIP’s data on “nearly 5 million policyholders” and the average flood insurance policy is kept for an average of three to four years. FEMA, who runs the NFIP, has decided to take a look at the current one year policy term and evaluate whether or not they should extend the current policy terms to multi-year insurance contracts to hold onto policyholders for a longer period of time. He said this will “encourage better risk management and help make America more resilient to flooding.”

Below is a link to the original article published in the Insurance Journal. Please click the link to read the key pillars of the new risk architecture mentioned in this blog. These are an important part of the issues discussed in this post.

 http://www.insurancejournal.com/news/west/2011/05/10/197839.htm