The costs of catastrophic risks and strategic risk management

1. Management of
Catastrophic Risks
By: Tara Ard
Kevin Cook
Marcus Gadson
Brad Kreuzinger
Terri Menser
Payal Patel
Kristin Sims
Harris Weinstein

2. Catastrophic Risk
A brief overview…

3. Landslides/ Mudslides
• Mountains
• Hilly areas
• Rain

5. Liquefaction

6. Floods

7. Tsunami

8. Blizzards, Snowstorms, Hail

9. Where Does Hail Happen

10. Tornadoes

11. Hurricanes

12. Thunderstorms

13. Wildfires, Building Fires

14. Terrorism
• Incredible variation in potential methods
usable.
– Bombing, Dirty Bomb, Biological, Nuclear
• Hard to predict.
• University of Alabama research
– “Our research won’t predict that an attack
targeting civilians at a public market will take
place tomorrow at 9:30 a.m.”

15. Likely Terrorism Targets

16. Biggest Types of Losses Following a
Catastrophic Event

17. Background
• There is a trend of increasing losses
from natural catastrophic events since
the early 1980’s
– Increasing number of natural disasters
– Increasing density of population

18. Landslides
• Landslides currently are the only
uninsurable natural disaster by
private insurance companies
• In recent years, it is estimated
landslides have caused $1-2 billion
worth of damage
• Largest losses from landslides:
– Structural and property damage
– Casualties

19. Floods
• According to the National Flood Insurance
Program, floods are America's most frequent
and costly natural disaster
• Losses from floods include:
– Human mortality
– Damage to personal property from flood water
– Damage to real property (structural damage)
• Includes inside walls, and the resulting mildew,
mold, and fungus
– Under FEMA, Damage due to mudflow
• Flowing mud that inundates the home
– Under commercial policies, business
interruption

20. Blizzards and Snowstorms
• Largest losses:
– Economic losses
• Property damage
• Infrastructure damage
• Loss of business activity
– Insurance claims
• Automobile
– Livestock

21. Tornadoes
• According to the Insurance Information
Institute, tornadoes have accounted for
over a quarter of all catastrophe losses
from 1987 through 2006.
• Biggest losses:
– Property
• wind damage
• Water damage
– Human casualties
• Lack of warning

22. Hurricanes
• Hurricane Katrina of 2005 is the most
destructive and costly hurricane in
U.S. history
• Largest Losses:
– Property and infrastructure damage
• Flood damage
• Wind damage
– Loss of lives

23. Fire
• Biggest types of losses:
– Personal property
– Commercial property
– Forest and wildlife
– Human casualties

24. Terrorism
• Biggest losses:
– Human casualties
– Disruption of business operations
– Personal, real, and commercial property

25. Earthquakes
• Largest types of losses:
– Property losses
– Damage from flooding
– Public infrastructure

26. Most Costly Catastrophic Events in
2008
Most Costly Insured Catastrophe Losses in 2008
Catastrophe When Where Insured Losses
Hurricane Ike September US, Caribbean $20 billion
Hurricane Gustav August US, Caribbean $4 billion
Tornadoes, rainfall,
hail
May US $1.325 billion
Winter storm
Emma
February Europe $1.321 billion
Snow storms, ice January China $1.3 billion
Thunderstorms,
hail
May US $1.1 billion

27. What is Involved in Managing
Catastrophic Risk?
• 5 basic steps to useful risk
management program, regardless of
peril:
– 1) Understanding current level of
exposure
– 2) Assessing acceptability of risk
– 3) Evaluating alternative risk mitigation
– 4)Selecting an approach
– 5) Implementing the approach

28. Managing Catastrophic Risk
• While earthquakes are often considered the
most terrifying of natural disasters,
windstorms, including hurricanes and
tornadoes, actually produce greater annual
losses than those of earthquakes.

29. Managing Catastrophic Risk
• New building codes
– International Building Code
– Wind Borne Debris Codes
– Florida Building Code
• Computational fluid dynamics
programs
– Wind flow patterns can be modeled
around proposed and existing buildings

30. Managing Catastrophic Risk
• Terrorist Risk Management Program
– Phase I: Threat identification and initial site
assessment
– Phase II: Detailed risk assessment
• Determine the impact of a particular terrorist event
(ie: blast and explosion analysis, progressive
collapse analysis, chemical, biological, and
radiological threat assessment)
– Phase III: Risk management
• Protection of facility and occupants
• Emergency planning and disaster recovery
• Reduction of financial risk

31. Managing Catastrophic Risk
• Reduction of financial risk
– Diversifying
– Pooling
– Charging premiums

32. Why Insuring Against Risks is
Complicated?
1. New Threats
2. Priorities
3. Sunk Costs
4. Expensive

33. How Are Catastrophic Risks
Managed in Other Countries?

35. • Rich countries’ luxuries
• Post-disaster recovery by government
• Little political incentive
Catastrophic Management in
Developing Countries

36. Catastrophic Management in
Developing Countries
• Private funding
– Post-disaster borrowing
– International Donations
• Lack of immediate cash hinders recovery
– Creates spillover effect
• World Bank has donated 40 billion for
natural disaster recovery over the past 30
years
• World Bank Global Initiative

37. Real Life Example: Haiti
• Most deprived nation of the Western
Hemisphere
• No national building code
• Limited water and power distributions
hampered relief efforts
• Over 250,000 fatalities, many due to lack
of medical care (20,000 a day)
• As of March 2010, Red
Cross has raised over
100 million in relief
efforts.

38. The U.S. General Accountability
Office
Study of systems in France, Germany, Italy,
Spain, Switzerland and the UK undertaken.
Each was found to have developed and employed a
combination of public and private approaches to deal with
catastrophes but only three impose government-mandated
insurance that cover disaster risk.
Accounting standards and tax laws in each of the six
countries studied allowed insurance companies to
establish tax-deductible reserves for future catastrophic
events, although there can be significant differences in the
reserving approaches used in each country.

39. Catastrophic Insurance in select EU Countries

41. Alternative Risk Transfer
• Purpose of Alternative Risk Transfer
(ART) is for Insurance Companies to
ensure that they have enough liquidity to
pay for claims filed in the event of a
catastrophic loss
• Some methods of ART include:
– (1) Contingent Surplus Notes (CSNs)
– (2) Exchange Traded Catastrophic Options
– (3) Catastrophe Bonds
– (4) Sidecars

42. Alternative Risk Transfer
• Contingent Surplus Notes (CSN)
– Allows insurance company to pay for a catastrophe
over an extended period of time
• (1) Insurance company sets up a trust which buys U.S.
Treasuries and sells the notes to investors
• (2) Investors receive interest from bond + additional
interest from insurance company for the added risk
• (3) At time of a catastrophe, Insurance company has
legal right to substitute its own notes (CSNs) for the
U.S. notes – giving Insurance Co. immediate liquidity
– Interest and principal are still paid on the notes, but now the
investor has taken on a greater risk of financial default

43. Alternative Risk Transfer
• Exchange Traded Catastrophe Options
– Began on the Chicago Board of Trade in 1992
• Discontinued in 1999 because it lacked a viable market
• How it worked:
– Speculators sold options to Insurance Companies
who were paid when the specified index of
catastrophic losses reached a certain value
• E.g. Insurance Company is paid at the strike price of its
contract
– Alternatively, there were put options, where
Insurance Companies bought the right to sell
shares to investors at the strike price

44. Alternative Risk Transfer
• Catastrophe Bonds (Cat Bonds)
– Risk-linked securities that transfer risk to investors
– Floating rate bond structure
– Typically returns LIBOR plus a spread to investors
– If triggered (catastrophe occurs) the principal paid
to an insurer is forgiven and used to pay claims
– Appeal to investors because they are largely
uncorrelated with other assets in a portfolio
– Typically rated below investment grade (BB and
B)

45. Alternative Risk Transfer
• Reinsurance Sidecars (or just Sidecars)
– Financial structures that are created for investors to
take the risk and return of a group of policies
– Insurer only pays premiums if the investors place
sufficient funds to ensure they can meet claims
– Investors’ liability limited to funds they put in
– Rose in popularity after Hurricane Katrina
• Raise funds from capital markets investors
• Avoid existing reinsurers with past liabilities
• Avoid new reinsurers with lengthy and expensive “ramp
up” period

46. Questions?