What If It Got Worse Than Hurricane Sandy?

It was only two years ago this month that Hurricane Sandy ripped through the northeastern United States and mauled New Jersey and New York, including the Big Apple, with a particular malice. Sandy pummeled coastlines and destroyed businesses, homes and lives all in a 24-hour turnaround. And the price tag wound up being US $68 billion in economic damage.

And yet, the storm isn’t the biggest natural disaster the region’s experienced. It’s seen worse—much worse. Back in September of 1821, Mother Nature curled up her fist and pounded the northeast coast in a wallop known as the Norfolk Long Island Hurricane. While that might normally be of interest only to weather trivia geeks and subscribers to The Old Farmer’s Almanac, consider this: with the right sophisticated model, we can actually time travel in a way to find lessons for if it happens again.

A little more background first on the 1821 event. The storm made landfall in North Carolina as a Category 4 hurricane and proceeded to tear a path of destruction from the Outer Banks of North Carolina up to Massachusetts. Coastal communities in North Carolina were washed away, ships in Norfolk, Va. were pushed ashore, and the Delaware Bay flooded Cape May, N.J. Now just take a minute and think about the limited resources for recovery in an era before phones, before automobiles, let alone sophisticated construction equipment for clearing debris, and how little medicine could accomplish back then! No wonder that on eastern Long Island in New York, locals described the aftermath as “the most awful and desolating ever experienced.”

Using tropical cyclone wind and storm surge models, we recreated a track for this event, along with wind speeds and storm surge depths throughout the affected area. To say Norfolk was a powerful hurricane would be an understatement; its winds were gusting as far north as Maine, with winds in excess of 160 kilometres an hour along the coasts of North Carolina, Delaware, New Jersey and New York, and 16 to 25 feet of storm surge was inundating popular tourist spots like the Outer Banks of North Carolina and Atlantic City, N.J. The loss potential from another “super hurricane” like this would be staggering: more than US $100 billion in physical damage alone, and approximately $150 billion in economic losses.

Storms on Other Horizons

We all remember how horrible last year was for Canada, not only with Calgary’s drenching, but Toronto’s flash floods, which resulted in $940 million in insured losses. That year also marked the fifth consecutive year in which Canada experienced weather losses in excess of $1 billion. Other recent events outside of North America provide additional sobering lessons about the financial impact of natural disasters. New Zealand was well-prepared for the Christchurch earthquake in September 2010. But, the far more devastating aftershock six months later in February 2011 was a tipping point, triggering fervent discussion about the cost and availability of insurance going forward, and the role of the government and private sector in disaster risk management and post-event financial recovery. Japan lost roughly five percent of its GDP in a matter of minutes after the March 2011 9.0-magnitude quake off the main island of Honshu. Insurance covered only 17 percent of the total loss, and the government and taxpayers have had to absorb the remainder.

Increasing losses due to natural perils, such as earthquake, flood, tropical cyclone, and winter storm, are an ongoing trend. Not every dollar of losses is covered by the private insurance industry, and the uninsured portion of the loss becomes the financial burden of the government and, ultimately, the taxpayers, who likely are already dealing with the long-term consequences of the disaster itself.

The ever-increasing burden on governments is not a theoretical concept; the impact is already very much discernable in Canada. The cost-sharing arrangement between the federal government and provinces and territories for disasters, known as the Disaster Financial Assistance Agreement (DFAA), has ballooned in a short time. In fact, 96 percent of all payments out of the DFAA have been made since 1996, and the program has existed for nearly 45 years. On average, nine payouts were made annually in the previous decade, but in 2011 there were 26. Two years ago, the Canadian Forces announced it would begin charging local governments for assistance provided in the wake of natural disasters. This type of assistance is critical to the Canadian economy, and cannot be sustained without the help of other mechanisms, including pre-event risk financing.

Public-Private Partnerships

Insurance products developed by the private reinsurance and insurance industry, and designed specifically to address the needs of governments and other public sector entities, can play an important and significant role in holistic disaster risk financing schemes. These public-private partnerships transfer catastrophe risk from government entities to the private market. They can provide the governments with liquidity in the immediate wake of a natural disaster, and reduce the need for budget reallocation or tax increases to finance the disaster recovery post-event. These solutions also give government decision makers, for the first time, an independent, market-based estimate of a nation’s seismic, climate and weather risk. By putting a price tag on unmitigated risk, a government can make more educated decisions in how to allocate its financial and human resources towards risk prevention and mitigation.

Risk management expertise can mean developing individualized coverage tailored to the needs of a specific government and the sectors they protect. For example, parametric or index-based insurance products can be designed to cover the intangible economic impacts of natural disasters, such as emergency infrastructure repairs, lost tax revenue or the overtime salaries of first responders. Parametric insurance products settle on the characteristics of the event, not the actual loss, eliminating a potentially lengthy claims process and quickening the time between loss and settlement.

Numerous examples of successful public-private partnerships exist in the market already, both in developing and developed economies. The Mexican government is among the most advanced in the world when it comes to disaster risk financing, using a combination of traditional indemnity insurance and a catastrophe bond to protect itself from the impact of earthquake, tropical cyclone, and flood.

The Caribbean Catastrophe Risk Insurance Facility (CCRIF) provides 16 countries with tropical cyclone and earthquake protection. CCRIF was developed with funding from the Japanese government, and originally capitalized through contributions to a multi-donor trust fund by the government of Canada, the European Union, the World Bank, the governments of Bermuda, Ireland, the U.K., and France, and the Caribbean Development Bank. Incepted in 2007, CCRIF has already paid out eight times to a subset of its member countries. In 2010, in the weeks after the magnitude 7.0 quake, the Haitian government received a payment from CCRIF that enabled the country to continue to finance its police force. Earlier this year, CCRIF announced plans to expand its coverage to Central America, which will be an important step in increasing the financial resilience of the area to both seismic and weather hazards.

The concept of the facility was replicated on the other side of the world in the form of the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI). The Pacific Island countries are at the forefront of the battle against climate change, and the initiative provides six Pacific Island nations with protection against the financial impacts of tropical cyclone, earthquake and tsunami. The program produced its first payoutinJanuary2014, after Cyclone Ian plowed through Tonga. In 1999, the government of Turkey implemented the Turkish Catastrophe Insurance Pool, which provides compulsory residential earthquake insurance to homeowners. It has greatly increased the penetration of earthquake insurance in Turkey and, in the event of an earthquake, a significant portion of residential loss would be covered by the insurance industry, not the government.

With its tremendous hurricane exposure, a school district in Miami recognized the importance of partnering with the industry to ensure that operations are protected. Miami-Dade County Public Schools implemented a multi-year structure to protect them against major disasters; but, more importantly, the deal provides them with budgetary certainty in the face of a growing threat.

Public-private partnerships are also being used to handle less dramatic, but still damaging, weather threats. In January 2014, Uruguay’s state-owned hydroelectric power company entered into a derivative contract with the World Bank in the event it needs to purchase energy from alternative sources because of drought conditions. The risk associated with the joint weather-commodity derivative was ceded to the private insurance market, with Swiss Re and Allianz each taking a share of the $450-million transaction. The heavy rains that occurred in St. Vincent and St. Lucia during Christmas 2013 caused over $100 million in damage, and demonstrated the Caribbean’s vulnerability to extreme rainfall. Mere months later, the CCRIF launched an excess rainfall cover to protect its member countries against the financial impacts of heavy rainfall and flooding.

Another example comes from Mexico. In 2003, in an effort to protect farmers during a drought, the Secretariat of Agriculture purchased an index insurance product that relies on satellite measurements of vegetation to determine drought severity, and if necessary, make a payout so that farmers can purchase additional feed for their animals.

Now is the time to turn talk into action and implement disaster risk financing strategies —before the next big storm, fire or earthquake. The insurance industry can and should be an important partner of governments at all levels by assuming some of the natural hazard risk currently self-insured by the government and increasing the financial resiliency of the governments and ultimately, their populations, in the aftermath of a natural catastrophe.

Megan Linkin is a natural hazards expert for the Global Partnerships team at Swiss Re America in Armonk, New York.

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Copyright 2014 Rogers Publishing Ltd. This article first appeared in the October 2014 edition of Canadian Insurance Top Broker magazine

This story was originally published by Canadian Insurance Top Broker.