Risk Management Reports

These four hurricanes of 2004, ones that lacerated the Caribbean and the southeast US, remind me that natural disasters continue to defy rational response. As risk managers we have over 100 years of records of occurrences of floods, earthquakes, typhoons, cyclones, hurricanes, tornados, tsunamis and similar “natural” events. Our predictive abilities have improved dramatically during this century, radically reducing death tolls, at least in the more economically developed societies, even while the economic damage has skyrocketed. Why is this? Perversely, many people move to wind and earthquake-prone regions in the belief that, first, it won’t happen to them, and second, even if it does, “government” will bail them out with financial awards. The result is that the many (taxpayers in general and those who contribute to charitable relief organizations), end up subsidizing continued folly. Yes, many of the more responsible carry insurance, but even then, other policyholders serve as co-payers of their losses through increased premiums. Insurance itself covers only a modest portion of total losses. According to Munich Reinsurance Company, in 2002, the world sustained $55 billion in total damages from some 500 “natural disasters.” Less than 25%, or $13 billion was insured, leaving the remainder to be borne by victims and society.

Howard Kunreuther, at the University of Pennsylvania’s Risk Management & Decision Processes Center, a part of its Wharton School, continues to be a vocal advocate of a more sensible approach to reducing these disasters’ economic carnage. It isn’t enough to enact strict land use planning and building codes that apply to both existing and new structures.He argues that a combination of financial incentives and penalties must be used to change behaviors. The scattered wreckage of mobile homes in this year’s hurricanes in the southern US is testimony to the lack of political will to enforce rational responses. The states, the federal government and the private sector (banks, mortgage companies and insurance companies alike) are complicit in their unwillingness and inability to adopt sensible solutions experts have recommended for years. In the latest issue of the Center’s Risk Management Review (http://opim.wharton.upenn.edu.risk), Professor Kunreuther again argues that enhanced land use and building codes must be enforced with rigor,supported by financial rewards and penalties. Mortgage sellers must require that homes and businesses meet state standards before granting loans. Similarly, insurance companies must refuse to underwrite structures without proper wind reinforcements or when they are sited in a flood plain, leaving their owners to bear the entire financial burden of their improvident behavior. And, most importantly, disaster funding from state and local governments must not be offered to those who failed to meet standards and who subsequently sustained losses from major events. This last mandate, however, runs counter to the natural instincts of politicians whose sole purpose is re-election. In any election year, the public coffers are opened, especially in critical swing states such as Florida. Professor Kunreuther acknowledges these problems, but he has some smart suggestions for anticipating the next disaster. Instead of requiring homeowners and business-owners to ante up the relatively high costs of retrofitting their buildings with current dollars or short-term borrowing, he proposes that such costs be folded into existing mortgages, thus spreading them over many more years and reducing immediate pain. That’s a financial incentive worth considering, something supportable by other taxpayers. Some tax deductibility for a portion of these expenses is another option.

The problem, of course, is that all this sensible advice requires close coordination among local, state and federal governments as well as among banks, mortgage companies, insurers, and reinsurers, something that has not happened yet. It may be too much to ask, yet I applaud Professor Kunreuther for his ongoing efforts to change the status quo.

Reducing both death and economic losses has also been the goal of the United Nations International Strategy for Disaster Reduction (ISDR) (www.unisdr.org), the successor to its successful International Decade for Disaster Reduction, carried out from 1990 through 1999. Its focus is the monumental loss that occurs annually in the less developed world, where the vulnerability of people and societies is dramatic. As ISDR reports in its latest publication (Living with Risk: A Global Review of Disaster Reduction Initiatives, United Nations, Geneva 2004: (see www.un.org/Pubs/sales.htm), the developing world has the highest population growth (70 to 80 million per year) coupled with the “smallest share of resources and the biggest burden of exposure to disasters.” Its conclusion is “that risk reduction and disaster preparedness always make better economic sense that reliance on disaster relief.” It recommends a combination of public debate, education and economic support, efforts that will have a material effect on the loss of life and property. It is a monumental tome, some 430 pages in the basic text, plus another 126 in appendices, but it should be invaluable for any organization that operates extensively in the developing world. Are you now outsourcing to India? Do you depend on parts or assembly from Southeast Asia, China and Central America? If so, you should be aware of the effects there of natural disasters and the means, outlined in this book, for more intelligent anticipation and response. In particular, the Annexes include a 57 page directory of international, national, regional and specialized organizations (with email addresses) involved with disaster reduction and related issue, invaluable should a risk manager seek assistance for an organization’s operations in specific countries.

Charley, Frances, Ivan and Jeanne again remind us of the importance of planning in anticipation of predictable natural disasters.