Dr L James Valverde, Jr

1
Casualty Actuaries of New England
Dr L James Valverde, Jr Vice President, Economics
and Risk Management Insurance Information
Institute 110 William Street New York, NY
10038 Tel [phone] Fax (212)
732-1916 jamesv_at_iii.org www.iii.org
26 September 2006
2
Broad Outline

• Two Views of Risk
• Managing Natural Catastrophes in a Post-9/11
  World
• Government as Ultimate Risk Manager What Role
  Should the Federal Government Play in Managing
  Extreme Events?

3
First ViewManaging Natural Catastrophes in a
Post-9/11 World
4
Components of the First View

• Catastrophe Loss Management The Hurricane
  Seasons of 2005 and 2006
• Managing Natural Catastrophes The Larger
  Context
• Emergency preparedness and response in the wake
  of 9/11
• Questions and emerging lessons from Hurricane
  Katrina
• The U.S. Department of Homeland Security
• Historic moment for America or bureaucracy writ
  large?
• Emergency Preparedness and Response
• All-hazards vs. terrorist myopia?
• FEMA Challenges in the years ahead

5
Catastrophe Loss ManagementThe Hurricane
Seasons of 2005 and 2006
6
Most of U.S. Population and Property has Major
CAT Exposure
Is Anyplace Safe?
7
2005 Was a Busy, Destructive, Deadly, and
Expensive Hurricane Season
All 21 names were used for the first time ever,
so Greek letters were used for the final storms
2005 set a new record for the number of
hurricanes tropical storms at 28, breaking the
old record set in 1933
Source WeatherUnderground.com, January 18, 2006.
8
2006 Hurricane Season Much Less Active Than
Expected
What a difference a year makes! Just 8 named
storms through 18 Sept 2006 vs. 17 as of same
date in 2005!
Source WeatherUnderground.com, September 17,
2006.
9
2006 Hurricane Season Forecasts Repeatedly
Scaled Back
2006 hurricane seasons has turned out to be far
less severe than anticipated
Average over the period 1950-2000. Source
Insurance Information Institute compilation of
forecasts by Dr. William Gray, Colorado State
University.
10
U.S. Insured Catastrophe Losses ( Billions)
100B CAT year looms on the horizon
Billions
2005 was by far the worst year ever for insured
catastrophe losses in the US, but the worst has
yet to come
Excludes 4B-6b offshore energy losses from
Hurricanes Katrina Rita. As of June 30,
2006. Note 2001 figure includes 20.3B for 9/11
losses reported through 12/31/01. Includes only
business and personal property claims, business
interruption and auto claims. Non-prop/BI losses
12.2B. Source Property Claims Service/ISO
Insurance Information Institute
11
Number of Major (Category 3, 4, 5) Hurricanes
Striking the U.S. by Decade
1930s mid-1960s Period of Intense Tropical
Cyclone Activity
Mid-1990s 2030s? New Period of Intense Tropical
Cyclone Activity
10
Tropical cyclone activity in the mid-1990s
entered the active phase of the multi-decadal
signal that could last into the 2030s
Already as many major storms in 2000-2005 as in
all of the 1990s
Figure for 2000s is extrapolated based on data
for 2000-2005 (6 major storms Charley, Ivan,
Jeanne (2004) Katrina, Rita, Wilma
(2005)). Source Tillinghast from National
Hurricane Center http//www.nhc.noaa.gov/pastint.
shtm.
12
Top 10 Most Costly Hurricanes in US History,
(Insured Losses, 2005)
Seven of the 10 most expensive hurricanes in US
history occurred in the 14 months from Aug. 2004
Oct. 2005 Katrina, Rita, Wilma, Charley, Ivan,
Frances Jeanne
Sources ISO/PCS Insurance Information
Institute.
13
Insured Loss Claim Count for Major Storms of
2005
Hurricanes Katrina, Rita, Wilma Dennis produced
a record 3.3 million claims
Property and business interruption losses only.
Excludes offshore energy marine losses. Source
ISO/PCS as of June 8, 2006 Insurance Information
Institute.
14
Hurricane Katrina Insured Loss Distribution by
State ( Millions)
Louisiana accounted for 62 of the insured losses
paid and 56 of the claims filed
Total Insured Losses 40.579 Billion
As of June 8, 2006 Source PCS division of ISO.
15
Hurricane Katrina Loss Distribution by Line (
Billions)
Total insured losses are estimated at 40.579
billion from 1.7438 million claims. Excludes
2-3B in offshore energy losses
As of June 8, 2006 Source PCS division of ISO.
16
Hurricane Rita Claim Count Distribution by State
Louisiana accounted for 48.3 of the insured
losses, Texas 44.6. Excludes offshore energy
losses of 2-3B
Total Claims 383,000
As of June 8, 2006 Source PCS division of ISO.
17
Hurricane Rita Loss Distribution, by Line (
Millions)
Total insured losses are estimated at 5.0
billion (excl. offshore energy of 2-3B) from
383,000 claims.
As of June 8, 2006 Source PCS division of ISO.
18
Hurricane Wilma Loss Distribution by Line (
Millions)
Total insured losses are estimated at 10.3
billion from 1.047 million claims
As of June 8, 2006. All losses are in
FL. Source PCS division of ISO.
19
Inflation-Adjusted U.S. Insured Catastrophe
Losses By Cause of Loss, 1986-2005¹
Insured disaster losses totaled 289.1 billion
from 1984-2005 (in 2005 dollars). Tropical
systems accounted for nearly half of all CAT
losses from 1986-2005, up from 27.1 from
1984-2003.
1 Catastrophes are all events causing direct
insured losses to property of 25 million or more
in 2005 dollars. Catastrophe threshold changed
from 5 million to 25 million beginning in 1997.
Adjusted for inflation by the III. 2 Excludes
snow. 3 Includes hurricanes and tropical storms.
4 Includes other geologic events such as volcanic
eruptions and other earth movement. 5 Does not
include flood damage covered by the federally
administered National Flood Insurance Program. 6
Includes wildland fires.
Source Insurance Services Office (ISO)..
20
Total Value of Insured Coastal Exposure (2004,
Billions)
Florida New York lead the way for insured
coastal property at more than 1.9 trillion each
Source AIR Worldwide
21
Insured Coastal Exposure as a of Statewide
Insured Exposure (2004, Billions)
After FL, many Northeast states have among the
highest coastal exposure as a share of all
insured exposure in the state
Source AIR Worldwide
22
Value of Insured Commercial Coastal Exposure
(2004, Billions)
Commercial property exposure also implies
significant business interruption losses
Source AIR
23
The 2006 Hurricane SeasonLowering Expectations
24
Outlook for 2006 Hurricane Season
Average over the period 1950-2000. Source Dr.
William Gray, Colorado State University,
September 1, 2006.
25
Probability of Major Hurricane Landfall (CAT
3,4,5) in Sept/Oct 2006
Average over past 52 years. Source Dr. William
Gray, Colorado State University, September 1,
2006.
26
Managing Natural Catastrophes in a Post-9/11 World
27
The Broader ContextHomeland Security
28
The Genesis of DHS

• In the wake of 9/11, President Bush issued the
  National Strategy for Homeland Security in July
  2002.
• Legislation creating the U.S. Department of
  Homeland Security (DHS) was signed in November
  2002.
• The creation of DHS represents a fusion of
  numerous federal agencies, with the objective of
  coordinating and centralizing the leadership of
  the nations homeland security activities under a
  single, cabinet-level department.
• Began operations in March 2003
• 22 separate agencies
• Approximately 180,000 employees

29
DHS Historic Moment for the United States or
Bureaucracy Writ Large?

• The creation of DHS represents a historic moment
  of almost unprecedented action by the federal
  government to transform how the nation protects
  itself from acts of terrorism.
• Rarely in the nations history has such a large
  and complex reorganization of government been
  attempted, with such a singular and urgent
  purpose.
• DHS represents a unique opportunity to transform
  a disparate group of agencies with multiple
  missions, values and cultures into an effective
  cabinet-level department.
• A central aspect of DHSs mission involves
  coordinating efforts to protect critical
  infrastructure, prepare for possible attacks and
  other emergencies, and respond to catastrophic
  incidents and events.
• Accountability and performance thus far?
• Hurricane Katrina as a specific case in point
  first real test of the system
• DHS Inspector General
• U.S. GAO
• Academics and Think Tanks

30
Homeland Security The Essential Tension

• Any coordinated and sustained effort to
  effectively manage homeland security must contend
  with two competing objectives/tasks
• The prevention of terrorist acts
• Mitigation of consequences arising from acts of
  terrorism and other extreme events
• In a difficult decision context like this, the
  allocation of resources under what is, in
  reality, deep and pervasive uncertainty is one of
  the central challenges the federal government
  faces in its efforts to manage homeland security

31
The National Strategy for Homeland Security

• The National Strategy for Homeland Security
  describes six critical missions areas
• Intelligence and Warning
• Border and Transportation Security
• Domestic Counterterrorism
• Protecting Critical Infrastructure and Key Assets
• Defending Against Catastrophic Threats
• Emergency Preparedness and Response
• The President has also issued several additional
  documents called Homeland Security Presidential
  Directives (HSPDs) that provide more detailed
  guidance on various homeland-security-related
  mission areas and initiatives.

32
Emergency Preparedness and Response Key Elements
of the National Strategy

• Within the Emergency Preparedness and Response
  mission
• area, the National Strategy identifies 12
  separate initiatives
• Integrate separate federal response plans into a
  single all-discipline incident management plan
• Create a national incident management system
• Improve tactical counter terrorist capabilities
• Enable seamless communication among all
  responders
• Prepare health care providers for catastrophic
  terrorism
• Augment Americas pharmaceutical and vaccine
  stockpiles

33
Emergency Preparedness and Response Key Elements
of the National Strategy (cont.)

• Prepare for chemical, biological, radiological
  and nuclear decontamination
• Plan for military support to civil authorities
• Build the Citizen Corps
• Implement the First Responder initiative of the
  FY03 budget
• Build a national training and evaluation system
• Enhance the victim support system

34
FEMA

• Past, Present, and Future

35
DHS Organizational Structure FEMAs Place in the
Larger Context of Homeland Security
36
FEMA Informed Opinion Prior to this Years
Devastating Hurricane Season

• consolidate DHS response missions into FEMA
  and strengthen that agency. FEMA should be
  engaged squarely in its traditional role of
  planning for national (not just federal) response
  to emergencies. emphasis added
• DHS 2.0
• Heritage Foundation
• December 2004

37
FEMA in the Wake of Hurricane Katrina

• FEMA has, of course, become synonymous with the
  governments bungled response to the hurricane.
• To what extent is this a fair characterization of
  this agency and the difficult situation it now
  finds itself in?
• Skepticism going forward

38
FEMA What Went Wrong and Why?

• Many theories and explanations have been
  forthcoming
• Much of what is currently being said contains the
  following core elements
• The agency is no longer cabinet-level, but rather
  a small cog within the organizational and
  bureaucratic behemoth that is DHS
• FEMAs mission to help states prepare for all
  hazards from terrorism to natural disasters
  has become lost within DHSs myopic focus on
  terrorism.
• FEMA should perhaps revert to being an
  independent, cabinet-level agency

39

• The Centrality of the All-Hazards Context

40
HSPD 8 National Preparedness The National
Planning Scenarios

• Developed under the leadership of the Homeland
  Security Council
• Overarching goals are to
• Create the agility and flexibility to meet a wide
  range of threats and hazards
• Provide a structure for the development of
  national preparedness standards
• 15 planning scenarios provide parameters
  regarding the nature, scale, and complexity of
  incidents of national significance, which include
  both terrorism and natural disasters.
• Each scenario provides a basis for defining
  prevention, protection, response, and recovery
  tasks that need to be performed, as well as
  required capabilities.

41
The National Planning Scenarios

• The Homeland Security Council has developed 15
  all-
• hazard planning scenarios for use in national,
  federal,
• state and local homeland security preparedness
  activities
• Nuclear Detonation 10-Kiloton Improvised
  Nuclear Device
• Biological Attack Aerosol Attack
• Biological Disease Outbreak Pandemic Influenza
• Biological Attack Plague
• Chemical Attack Blister Agent
• Chemical Attack Toxic Industrial Chemicals
• Chemical Attack Nerve Agent

42
The National Planning Scenarios (cont.)

• Chemical Attack Chlorine Tank Explosion
• Natural Disaster Major Earthquake
• Natural Disaster Major Hurricane
• Radiological Attack Radiological Dispersal
  Devices
• Explosives Attack Bombing Using Improvised
  Explosive Device
• Biological Attack Food Contamination
• Biological Attack Foreign Animal Disease (Foot
  and Mouth Disease)
• Cyber Attack

43
Scenario 10 Natural Disaster A Major Hurricane

• In this scenario, a Category 5 hurricane hits a
  major metropolitan area
• Sustained winds are at 160 mph, with a storm
  surge greater than 20 feet above normal
• As the storm moves closer to land, massive
  evacuations are required
• Some low-lying escape routes are inundated by
  water anywhere from 5 hours before the eye of the
  hurricane reaches land
• Consequences associated with Scenario 10

44
Looking Towards the FutureWhere Do We Go from
Here?
45
Challenges in Emergency Preparedness

• Adopting an All-Hazards Approach
• The National Strategy calls for the creation of
• a fully integrated national emergency response
  system that is adaptable enough to deal with any
  terrorist attach, no matter how unlikely or
  catastrophic, as well as all manner of natural
  disasters emphasis added
• Challenges
• Identifying the types of emergencies for which
  they should be prepared and the requirements for
  responding effectively
• Assessing current capabilities against those
  requirements
• Developing and implementing effective,
  coordinated plans among multiple first responder
  disciplines and jurisdictions
• Defining the roles and responsibilities of
  federal, state, and local governments and private
  entities

46
Challenges in Emergency Preparedness

• Improving Intergovernmental Planning and
• Coordination
• The National Strategy emphasizes a shared
  national responsibility involving all levels of
  government in responding to a serious
  emergency.
• In May 2004, GAO reported that a major challenge
  involves what they saw as lack of coordination
  within DHS in terms of the agencys ability to
  prepare for, respond to, and recover from
  terrorist and other emergency incidents
• there has been a lack of regional planning and
  coordination for developing first responder
  preparedness, defining preparedness goals,
  identifying spending priorities, and expending
  funds (GAO-04-433)

47
Challenges in Emergency Preparedness

• Establishing Emergency Preparedness
• Standards
• The National Strategy makes mention of
  benchmarks, standards and other performance
  measures for emergency preparedness.
• However, in January 2005, GAO found that
• there is not yet a complete set of
  preparedness standards for assessing first
  responder capacities, identifying gaps in those
  capacities, and measuring progress in achieving
  performance goals. (GAO-05-33)

48
FEMA The Story Thus Far

• Many are calling for Congress to restore FEMA to
  a separate, independent agency.
• In Congressional testimony some months ago, DHS
  Secretary Michael Chertoff acknowledged that
  Hurricane Katrina challenged the disaster relief
  system in a way that has not ever happened.
• He singled out planning as an area in need of
  improvement, saying it was responsible for 80 of
  the failures.
• Secretary Chertoff pledged to retool FEMA
• Improved aid delivery system
• Qualified senior leaders
• Modernizing business practices and communication
  systems
• However, Chertoff rejected the idea that FEMA
  should be removed from under the DHS umbrella.
• Partisan politics reigns supreme?
• Why shouldnt you be arrested for negligent
  homicide?
• Rep. Cynthia A. McKinney, D-GA

Source Congressional Quarterly
49
Implications and Challenges for P/C Insurers
and Reinsurers
50
Mismanagement of Emergency Preparedness and
Response Can Impact the Economic Losses
Associated with Natural Disasters

• Clearly, there is a relationship between
  recovery time and the economic losses
  associated with a natural catastrophe such as
  Hurricane Katrina
• Business interruption losses increase
  exponentially with response lag
• Fires burn uncontrolled
• Failed law enforcement, rioting and looting
• Delayed flood drainage
• Untimely mitigation of environmental
  release/contamination
• etc.
• While precise estimates of this relationship will
  require future empirical study, a couple of
  points are worth considering in light of Katrina
• A key responsibility for P/C insurers is to play
  their important and substantial role in the risk
  mitigation process.
• It is important for federal, state and local
  officials to understand and appreciate the role
  that insurance can play in both minimizing loss
  and expediting recovery.
• Both P/C insurers and property owners, alike,
  have a vested interested in seeing that the
  overall system works as well as possible.

51
Challenges for P/C Insurers Uncertainty of Losses

• Natural disasters pose vexing challenges for
  insurers because they involve potentially high
  losses that are characterized by large degrees of
  uncertainty.
• Moreover, natural disasters involve spatially
  correlated losses or the simultaneous occurrence
  of many losses from a single event.
• Hurricane Katrina suggests a new externality
  for P/C insurers to consider
• Mismanagement of the governments response and
  recovery efforts in the affected region(s)

52
Rethinking Traditional Approaches to CAT Modeling
and Risk Management in Light of Katrina

• Traditional approaches to risk assessment and CAT
  Modeling need to be revised to explicitly
  consider some of these new externalities (e.g.,
  political uncertainty, etc.) into their overall
  analytical frameworks.
• A clear need for increased geo-spatial
  sophistication and detail within CAT models,
  combined with the ability to perform cascaded
  inference (broken levee ? ? ? ? ? evacuation of
  affected area).
• Seriously rethink the implications of changes in
  risk appetite/tolerance and ambiguity aversion
  for risk management strategies and corporate
  decision-making.
• Decision-Makers must become critical consumers of
  this technology not just passive receptors.

53
Summary Remarks

• The All-Hazards paradigm will become central to
  the policy dialogue in the years to come
• Policies and institutional regimes must be
  flexible and responsive to the evolving threat
  environment both man-made and natural
• TRIEA 05 is an important component in the
  countrys ability to confront and manage extreme
  events
• Public/Private partnerships are essential

54
Second ViewGovernment as Ultimate Risk
ManagerWhat Role Should the Federal Government
Play in Managing Extreme Events?
55
Components of the Second View

• Motivation
• The need for a public dialogue about natural
  disaster risk
• The Protection of People and Property as a
  Paramount Responsibility
• What Role Should the Federal Government Play?
• Potential Policy Responses What Works and What
  Doesnt
• Concluding Remarks

56
The Need for a Public Dialogue About Natural
Disaster Risk

• The hurricane season of 2005 will surely be
  remembered for decades to come not just for the
  human and economic toll that it extracted on
  those living in the Gulf Coast and Florida, but
  also for the profound influence it will have in
  shaping the public dialogue in the U.S. about how
  large-scale natural catastrophes should be
  managed in the post-9/11 era
• This dialogue holds the promise of engendering
  substantive changes in the interconnected web of
  social, political and economic systems that
  through a variety of formal and informal
  mechanisms shift, spread, or reduce the myriad
  risks that pervade life in the 21st century
• This years hurricane season brought with it a
  degree of destruction and devastation not seen in
  this country since the late 1920s
• Moving forward
• How should we, from a societal perspective, shape
  our collective destiny in light of what has
  tragically come to pass?
• How might we do things better the next time
  around, taking into consideration all of the
  attendant risks and complexities?
• What role should the federal government play in
  managing natural disaster risk?

57
Fundamental GoalThe Protection of People and
Property
58
Top 10 Deadliest Hurricanes to Strike the US
1851-2005
Hurricane Katrina was the deadliest hurricane to
strike the US since 1928
Could be as high as 12,000 Could be as high as
3,000 Midpoint of 1,000 2,000
range Associated Press total as of Dec 11,
2005 Midpoint of 1,100-1,400
range. Sources NOAA Insurance Information
Institute.
59
Global Number of Catastrophic Events, 19702005
The number of natural and man-made catastrophes
has been increasing on a global scale for 20 years
Record 248 man-made CATs record 149 natural
CATs in 2005
Man-made disasters without road disasters.
Source Swiss Re, sigma No. 1/2005 and 2/2006.
60
Insured Property Catastrophe Losses as Net
Premiums Earned, 19832005E
US CAT losses were a record 13.8 of net premiums
earned in 2005 and were 4.2 times the 1984-2004
average of 3.3
Insurance Information Institute figure of 13.8
for 2005 based estimated 2005 DPE of 417.7B and
insured CAT losses of 57.7B. Sources ISO, A.M.
Best, Swiss Re Economic Research Consulting
Insurance Information Institute.
61
What Role Should the Federal Government Play?
62
Two Countervailing Viewpoints

• In the vigorous public dialogue that has ensued
  in the wake of Hurricane Katrina, two
  countervailing viewpoints have emerged concerning
  how society should pay for mega-catastrophes
• Each of these viewpoints proceeds from a
  particular vantage point and set of beliefs about
  the role of government in managing and financing
  natural catastrophe risk
• On the one hand, there are those who believe that
  natural catastrophes are fundamentally
  uninsurable and that the federal government
  should serve as the ultimate risk manager in
  these instances
• Key assumption the federal government is in the
  best position to mitigate large losses (economic
  and otherwise), in economically efficient ways
• On the other hand, there are stakeholders in the
  debate that believe that the private sector and
  the free-markets are in the best position to
  adjudicate and manage these risks for those who
  choose to insure privately
• According to this view, the solution to the
  insurance dimension of this problem is not more
  government involvement and regulation, but
  rather, less
• Relaxing regulatory constraints and stringent tax
  policies will, they argue, stimulate markets to
  craft creative solutions to the problem of who
  pays? for mega-catastrophes.

63
Identifying Appropriate Federal Policy Responses

• In the coming years, these two opposing
  viewpoints will take center stage in numerous
  public policy debates seeking workable solutions
  to how we, as a country, move forward in light of
  the difficult lessons of Hurricane Katrina
• For its part, the U.S. Congress is likely to
  consider a broad range of proposals. For example
• Look for ways in which specific federal insurance
  programs like the National Flood Insurance
  Program can be improved
• Potentially sweeping changes in how the nation
  deals (both ex ante and ex post) with
  mega-catastrophes, both natural and man-made
• While it is early to speculate as to what this
  process will yield by way of specific mandates,
  statutes and potential reorganizations of
  government, it is clear that change will be an
  inevitable feature of the institutional
  arrangements, mechanisms and conceptual schemes
  that have traditionally governed our thinking
  about how disaster policy should be formulated
  and implemented in this country

64
The Case For a Federal Natural Catastrophe Program

• Arguments in favor of a substantive federal role
  in the financing of natural disaster risk almost
  invariably proceed from a rather basic premise
• some risks are simply too large or unpredictable
  to be
• insurable within the current institutional,
  financial and
• regulatory frameworks that govern private
  insurance
• markets in this country
• At the heart of these debates is the view that
  mega-catastrophes may soon exceed the ability and
  capacity of private insurance markets to deal
  effectively with incidents of this magnitude
• In the wake of Hurricane Katrina, some insurers
  and other relevant stakeholders are openly
  questioning whether natural catastrophes of this
  magnitude are insurable via the private markets

65
Policy Proposals Towards a Comprehensive NAT CAT
Plan

• Most of the proposals envisage a three-layer
  plan
• Policies sold by individual insurance companies
• State or regional catastrophe pools that provide
  reinsurance
• A national mega-catastrophe fund that provides a
  federal backstop for large-scale insured losses
• For its part, the U.S. House of Representatives
  has introduced two bills, the Homeowners
  Insurance Availability Act of 2005 (H.R.846) and
  the Homeowners Insurance Protection Act of 2005
  (H.R. 4366), both of which would create federal
  catastrophe reinsurance programs
• Under H.R. 846, the Treasury would auction
  so-called excess-of-loss reinsurance contractsa
  type of reinsurance that provides coverage above
  specified levels of loss
• Under H.R. 4366 the Treasury would be authorized
  to sell reinsurance contracts directly to
  eligible state catastrophe funds

66
NAICs Comprehensive National Catastrophe Plan

• Proposes Layered Approach to Risk
• Layer 1 Maximize resources of private insurance
  reinsurance industry
• Includes All Perils Policy
• Encourage Mitigation
• Create Meaningful, Forward-Looking Reserves
• Layer 2 Establishes system of state catastrophe
  funds (like the Florida Hurricane CAT Fund)
• Layer 3 Federal Catastrophe Reinsurance Mechanism

Source Insurance Information Institute
67
Objectives of NAICs Comprehensive National
Catastrophe Plan

• Should Promote Personal Responsibility Among
  Policyholders
• Supports Reasonable Building Codes, Development
  Plans, and Other Mitigation Tools
• Maximize the Risk Bearing Capacity of the Private
  Markets
• Should Provide Quantifiable Risk Management to
  the Federal Government

Source NAIC, Natural Catastrophe Risk Creating
a Comprehensive National Plan, Dec. 1, 2005
Insurance Information. Inst.
68
Existing Federal Insurance Programs

• Another reason that is often cited for expanding
  and enhancing the role of the federal government
  in financing natural catastrophe risk is that the
  federal government is, of course, already
  involved in numerous federal insurance programs,
  two of which deal specifically with natural
  disasters
• The Federal Crop Insurance Program
• The National Flood Insurance Program
• These two programs are subsidized by the terms
  stipulated in their authorizing statutes and, at
  present, participation in the programs is
  voluntary
• Programs such as these are often criticized for
  the inherent difficulties in assessing the
  governments true risk exposure and in setting
  premiums commensurate with that exposure
• Moreover, organizations such as the National
  Association of Insurance Commissioners have
  argued that requiring homeowners to purchase
  multiple insurance contracts to protect their
  property is both cumbersome and inefficient

69
Complicating Factors Going Forward

• Going forward, regulatory constraints may not
  allow insurers to charge actuarially sound rates
  that reflect the increased levels of risk
• Moreover, the price and availability of private
  reinsurance is volatile
• For these and a host of other reasons, the 2005
  hurricane season has given risk managers within
  the property/casualty insurance and reinsurance
  industries much to consider
• For example, with many of the exposure
  predictions and projected loss estimates made
  prior to this years hurricane season proving, in
  hindsight, to be grossly in error, catastrophe
  models have come under considerable criticism and
  scrutiny
• Many insurers and reinsurers are openly
  questioning their confidence in these models. As
  one exasperated insurance CEO recently exclaimed,
  They just dont know what theyre talking about
  they say these events are 1-in-100, 1-in-250,
  1-in-1000, or maybe its 1-in-1,000,000, but they
  have no idea
• Many within the industry fear that the risk
  assessment component of the insurance
  underwriting process may grow increasingly
  complex and unmanageable, as the coming decades
  may be marked by hurricane activity levels that
  well exceed recent historical baselines
• Difficult questions and complex scientific
  debates concerning the manner and degree to which
  global climate change is responsible for these
  emerging weather patterns will surely complicate
  matters even further

70
The Case Against a Federal Natural Catastrophe
Program

• Most of the reticence on the part of insurers to
  back the idea of a federal backstop for large
  natural catastrophes stems, at a basic level,
  from a firmly-rooted laissez-faire mindset as to
  how insurance markets should operate in the
  global economy
• They believe that increased federal involvement
  and regulatory authority in these markets is
  something to be avoided, because such actions
  hold the potential to, in effect, crowd out
  private insurance and reinsurance markets, and to
  stifle innovation within these markets
• In this context, it is often argued that the
  relationship between price and risk assumed is
  diminished, as federal insurance programs are
  rarely actuarially sound
• With regard, then, to natural catastrophe risk,
  the fundamental belief is that this class of risk
  is, indeed, insurable in the free markets

71
Does the Evidence Support the Free Market View?

• Perhaps the truest measure of the veracity of
  this claim is that the free markets have, thus
  far, performed well under especially trying
  conditions
• The global insurance industry has experienced
  unprecedented disasters over the past four years
• The tragedy of September 11th, at that time the
  most significant insurance catastrophe in history
• Record tornadoes and wildfires in 2003
• Four major hurricanes in Florida in 2004
• Hurricane Katrina will cost the insurance
  industry in excess of 40 billion, according to
  estimates by ISOs Property Claims Services, but
  more of the cost will be borne by reinsurers than
  in previous years

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Insurance Industry Resilience

• Wall Street analysts expect the insurance
  industry to be able to pay Katrina claims without
  any significant weakening of its overall
  financial strength
• Standard Poors has stated that, for most of
  the companies that the ratings agency follows,
  Katrina will depress earnings for several years
• Catastrophe reinsurers will be the most severely
  impacted segment of the industry, and prices for
  property catastrophe reinsurance will likely
  increase significantly due to heightened
  expectations concerning the frequency and
  severity of natural disasters worldwide
• Clearly, the industry has responded well during
  this unprecedented period, demonstrating both its
  financial resilience and its commitment to
  individual and corporate customers

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Potential Policy ResponsesWhat Works and What
Doesnt
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Successful Tools for Controlling Hurricane Risk
Exposure

• Strengthened building codes
• Stringent enforcement of building codes
• Fortified home programs
• Insurance rates based on sound actuarial
  principles (rates that are not government
  controlled) Works for commercial insurers
• Limits on underwriting
• Removing impediments to capital flows
• Incentives to adopt mitigation
• Forcing communities to consider their own
  catastrophe exposure

Source Insurance Information Institute
75
Unsuccessful Tools for Controlling Hurricane
Exposure

• Insurance rates that arent actuarially sound
• Political interference in rate process
• Inadequate underwriting controls
• Subsidies
• Intra-state (policyholders/taxpayers)
• US Taxpayer
• Litigation
• Retroactive rewriting of insurance contracts
• Low flood insurance penetration rates

Source Insurance Information Institute
76
Problematic Issues

• Local control of land use and permitting creates
  significant incentive problems
• Benefits accrue locally while many costs can be
  redistributed to others via taxes, insurance,
  insurance assessments and aid
• Prospect of government aid reinforces unsound
  building and location decisions
• States dont want to raise taxes to pay for
  mitigation/prevention even if state is sole
  beneficiary
• E.g., NO levees Beach replenishment

Source Insurance Information Institute
77
Recommendations for Controlling Hurricane Exposure

• Raise public awareness of risk
• Mandatory risk disclosure in all residential real
  estate transactions
• Require signed waivers if decline flood coverage
  that also waive rights to any and all disaster
  aid
• Continue to strengthen and enforce of building
  codes
• Allow markets to determine all property insurance
  rates
• Increase incentives to mitigate
• Require state-run insurer and reinsurer to charge
  actuarially sound rates
• Limit state-run insurer exposure to high-value
  properties
• Require communities/counties to a financial stake
  in their catastrophe exposure
• Reimburse disaster aid to state/federal government

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Concluding Remarks Moving Beyond the Potential
Impasse

• Regardless of where specific industry
  stakeholders stand on the continuum of viewpoints
  outlined above, there are areas where they may
  find some basis for agreement and common ground
• Most stakeholders will agree, for example, that a
  key responsibility for P/C insurers is to play
  their important and substantial role in the
  overall risk mitigation process
• In the case of large-scale natural disasters, it
  is important for federal, state and local
  officials to understand and appreciate the role
  that insurance plays in both minimizing loss and
  expediting recovery
• In order to move beyond the potential impasse in
  which the industry could find itself with regard
  to these issues, what is needed is an earnest
  attempt on the part of the public and private
  spheres to look for areas where government can
  facilitate market-enhancing opportunities and
  more efficient private-sector coordination
• Practical proposals to this end will include such
  activities as the encouragement of various loss
  mitigation strategies, including strong building
  codes and improved land-use planning
• Going forward, the challenge remains one of
  finding workable means and mechanisms by which to
  align incentives in ways that jointly enhance
  social welfare and the market
• The two activities do not necessarily need to be
  viewed
• as being mutually exclusive

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