Management of Catastrophic Risks
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Management of Catastrophic Risks
By: Tara Ard
Kevin Cook
Marcus Gadson
Brad Kreuzinger
Terri Menser
Payal Patel
Kristin Sims
Harris Weinstein
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Catastrophic RiskA brief overview…
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Landslides/ Mudslides
• Mountains
• Hilly areas
• Rain
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Liquefaction
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Floods
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Tsunami
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Blizzards, Snowstorms, Hail
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Where Does Hail Happen
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Tornadoes
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Hurricanes
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Thunderstorms
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Wildfires, Building Fires
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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.”
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Likely Terrorism Targets
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Biggest Types of Losses Following a Catastrophic Event
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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
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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
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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
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Blizzards and Snowstorms
• Largest losses:– Economic losses
• Property damage
• Infrastructure damage
• Loss of business activity
– Insurance claims• Automobile
– Livestock
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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
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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
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Fire
• Biggest types of losses:– Personal property– Commercial property– Forest and wildlife– Human casualties
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Terrorism
• Biggest losses:– Human casualties– Disruption of business operations– Personal, real, and commercial property
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Earthquakes
• Largest types of losses:– Property losses– Damage from flooding– Public infrastructure
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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
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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
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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.
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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
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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
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Managing Catastrophic Risk
• Reduction of financial risk– Diversifying– Pooling– Charging premiums
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Why Insuring Against Risks is Complicated?
1. New Threats
2. Priorities
3. Sunk Costs
4. Expensive
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How Are Catastrophic Risks Managed in Other Countries?
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• Rich countries’ luxuries
• Post-disaster recovery by government
• Little political incentive
Catastrophic Management in Developing Countries
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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
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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.
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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.
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Catastrophic Insurance in select EU Countries
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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
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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
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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
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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)
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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
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Questions?