Introduction

Climate changes are known to be caused by shifts in Earth’s outer and inner forces (e.g., solar magnetic activity and release of energy in the crust). Outcomes of climate changes could be catastrophic, and quite a few indeed have been. Worse! The frequency of catastrophic events is rising, and the resulting damages are deadly and becoming more costly. Indeed, tropical and winter storms, floods, earthquakes, tsunamis and other primary and secondary perils violently remind us that the world is a risky place.

No universal definition of catastrophe exists. The majority of governments worldwide keep some flexibility in declaring certain events catastrophic. The United Nations has its own set of definitions, which Munich Re has adopted. For example, the UN defines “great natural disaster” as a catastrophe of such magnitude that the affected region’s capabilities to respond effectively are clearly overstretched and supra-regional or international assistance is required. In general, this means that fatalities number in the thousands, hundreds of thousands of people are made homeless, or economic losses reach exceptional orders of magnitude – depending on the economic circumstances of the countries concerned. Swiss Re defines it differently and uses currency- and casualty-indices for the classification. Nonetheless, they offer some useful summary data for us to do better risk management. We summarize the data during the past 40 years (Figures 1~3 by Swiss Re) as well as detailed data for 2011 (Figures 4~5 by Munich Re).

Human Nature and Catastrophes

While many scientists believe that global warming contributes to this trend, we find another compelling contributor – humans that are not only social but also know how to concentrate, store and use chemicals and energies. We contend this with three points. First, there is an increasing concentration of people and property in areas most exposed to catastrophic events. Population increases in many countries mean that people often have little choice but to settle in high-hazard areas.

Second, economic reasons explain much of the concentration trend.  Because of economies of scale or scope, many businesses marshal factors of production in close proximity or conduct distribution on a mega scale (e.g., expensive power plants and industrial zones). All of these may make economic sense, but they create enormous target risks in the physical environment. Additionally, people are drawn to areas that hold the potential for greater economic prosperity, such as cities. Already, more than 40 percent of the world’s population lives in large cities, twice the proportion of 40 years earlier. The proportion is projected to increase to 60 percent in another 40 years. The adverse effects of natural disasters in resulting mega-cities are multiplied. Not only is the potential for extensive loss of life and property destruction enormous, but also the thousands or even millions of displaced citizens becoming refugees exacerbate an already awful situation.

Finally, personal reasons explain this concentration trend. People want to live in pleasant locations, particularly when they retire or become more affluent and can afford second homes. Coastal areas continue to experience substantial population gains, with the need for additional and more expensive housing, more extensive infrastructure, and attendant commerce to support the population base. This means that other citizens are drawn there for economic reasons.

Our understanding of the causes and effects of natural catastrophes has improved measurably over the recent decades. This knowledge has allowed improved maps of natural hazards, building codes, construction standards and emergency preparedness. Scientists continue to refine mathematical models that attempt both to simulate and predict frequency and severity of natural catastrophes. All with only limited success! We thus understand the importance of post-loss risk management as well.

Economic Development and Catastrophes

We tend to conclude that developed economies are likely to suffer more of economic than casualty losses and other economies to suffer more of casualty than economic losses. For example, Swiss Re reports in 2012 that out of the 40 most costly insurance losses in 1970~2011:

• 21 of them occurred in the US and its surrounding regions (the US and the Gulf of Mexico);
• 10 in Europe (mainly in Western Europe including the UK);
• 5 in Japan (including one case involving Korea as well);
• 2 in New Zealand (including February 22, 2011 earthquake);
• 1 in Thailand (the Great Thailand Flood of 2011); and
• 1 in Chile (February 27, 2010 earthquake).

From examining the 40 worst catastrophes in terms of victims during the same period, Swiss Re reports that the June 2003 heat wave and draught across Continental Europe (Italy, France, Germany, etc.) ranked as the 13th worst with 35,000 casualties. The March 11, 2011 earthquake-tsunami and the 1995 Great Hanshin Earthquake ranked Japan with the 19th and 32nd worst catastrophes with 19,184 and 6,425 casualties, respectively. Other than one event in France, all other catastrophes occurred in developing economies, such as Bangladesh, China, India, Indonesia, Iran, Pakistan, Thailand and several Central and Latin American countries. Exceptions to this common understanding exist. For example:

• The most costly insurance loss in 2011 was the above noted 2011 earthquake-tsunami in Japan. The loss is estimated at, if not over, US 35 billion. The second costly one was the flood caused by heavy monsoon rains in Thailand, the cost of which is estimated at US 12 billion.

• The worst catastrophe in terms of victims in 2011 was none other than the March 2011 earthquake-tsunami in Japan. The severe storms and tornadoes in the US in 2011 ranked the country with the 8th worst catastrophe of the year.

Japan and Thailand

Both countries face multiple catastrophic risks – Japan with earthquake, tsunami, typhoon and (to a certain degree) flood; and Thailand with flood and tsunami (resulting from earth movement in Indonesian earthquake plate) -- the most devastating one of which being earthquake (and the resulting tsunami) risk in Japan and flood risk in Thailand. Both countries thus have an established risk control and financing programs at the national level.

Differences exist. The catastrophe risks in Japan – a developed economy with active capital markets – have attracted institutional investors interested in insurance-linked securitization (ILS). The risks are thus thoroughly analyzed by local and overseas (re)insurance companies for premium rating. Capital market interest in the risks in Thailand is found but not to the level leading to an ILS. We summarize below some key findings related to the recent catastrophic events in Thailand and Japan.

Thailand

• Under the short-term risk management program of the government, they studied the topology along Chao Phraya River and constructed floodgates to retain in or direct flood water to designated zones. The government compensates the landlords in the zones for the loss incurred by the government decision. Under the long-term risk management program, the government expands forests in the northern mountain area of the country.

• The Great Thailand Flood of 2011 is estimated to cost the Thai nonlife insurance industry about 500 billion baht ($18 billion). Most of them (about 470 baht for commercial insurance claims).
  • Several Japanese insurance companies (Tokyo Fire & Marine, Mutsui Sumitomo, MSIG) and AXA are most affected by this event. They were underwriting Industrial All Risk (IAR) risks of foreign factories in the affected zone. 15,000 plants or so have been damaged as a result of the flooding.

• The Office of Insurance Commission (OIC) released an ad hoc measures the help the industry mitigate the financial distress from the event. The measures include waiving insurance capital risk charge and reinsurance concentration risk charge on flood claim as well as revision on asset-backed liability regulation (i.e., maintaining only 60% of asset to back flood claim liability). These temporary measures end in June 2012.

• The government created the “National Catastrophe Insurance Fund in March 2012. Under this program, insurers retain a minimum risk of 0.5~1.0% and reinsurer the balance with the Fund that may arrange retrocession with overseas reinsurers. See the figure.

Source: “Insurance Circle” (March 2012), the OIC Thailand

Source: “Annual Report 2011, Japan Earthquake Reinsurance Company

Japan

• The Earthquake Insurance System. Japan introduced the first version of national earthquake insurance program in 1966 (two years after the June 1964 Niigata Earthquake). The program has been revised several times, the latest in May 2011 as shown in the figure below.
  • It remains as an optional rider to householders’ comprehensive insurance and as an automatic rider to storekeeper’s comprehensive insurance.
    • It covers losses caused by the perils of earthquake, volcanic eruption and tsunami. The losses can be total, 50% or 5%.
    • The limit of coverage is commonly 30~50% of the amount of insurance (maximum of which is also set at ¥50 million for building and ¥10 million contents)
    • It is estimated that there is a 70% probability of an earthquake with an epicenter directly below metropolitan Tokyo within the next 30 years. Nonetheless, only 28% of the houses in the area are covered by earthquake insurance.

• The Great Tohoku Earthquake of 2011. As of June 2011, the company received a total of 708,809 claims, completed investigation for 662,286 of the claims and paid 578,535 of the claims. The total payment was ¥1,030 billion ($13 billion).

Considerations