Winter of Our Discontent
It was both grim irony and strange coincidence. While Japan suffered the worst earthquake in its troubled geological history, Americans marked the bicentennial of “The Great Central Shakeout,” our own worst—but largely unknown—temblor.
In 1811, the central United States experienced a series of boneshakers so severe that the Mississippi River temporarily ran backwards. There was no way to measure the magnitude of the earth’s tremors then, but the shock, centered in New Madrid, Mo., was strong enough to knock dishes off cupboard shelves as far away as Washington, D.C. It caused little damage, however, because virtually nobody lived in the quake zone. If it happened today, millions would be vulnerable.
Japan’s disaster shows just how devastating an earthquake and its aftermath can be, particularly with resulting tsunamis and nuclear power plant explosions. While there’s no guarantee how the earth’s tectonic plates will move in the future, recent tremors in Chile, Haiti, and New Zealand make a compelling case that insurers—and everyone else—need to be prepared.
The most likely risk to the insurance industry will be seen in the reinsurance market. It will take a hit to earnings, but whether the Japanese losses will simply lower earnings or force giants like Munich Re and Swiss Re to dig into their capital bases to pay insurers’ covered losses hasn’t yet been answered. A Swiss Re spokesman simply said, “It will take some time to estimate the damage.”
But as more information trickles in from Japan’s triple-threat disaster, it’s unlikely that the first damage estimate of $35 billion in insured losses by disaster modeler AIR Worldwide will hold up. Another disaster modeler, EQECAT, has already estimated “total economic losses” in Japan will likely exceed $100 billion. That’s well above the previous most costly disaster—Hurricane Katrina, in 2005, at $71 billion. Reinsurers worldwide will certainly pay a major portion of the insured part of that loss.
Even if the $35 billion estimate is accurate, it must be added to a worldwide bill that now includes more than $20 billion for other recent disasters, says David Flandro, global head of business intelligence for reinsurance brokerage Guy Carpenter. These include two earthquakes centered in Christchurch, New Zealand, as well as flooding in Queensland and Cyclone Yasi in Australia. Many had also written insurance on the Deepwater Horizon loss in the Gulf of Mexico, according to Holborn Corp., a reinsurance broker.
“What makes the current disaster so extraordinary is that four of the five costliest earthquakes and tsunamis have happened in the last 13 months,” says Insurance Information Institute president Robert Hartwig.
A Harder Market
“In the first two months of 2011, some reinsurers had lost as much as they had budgeted for the whole year,” says Stan Loar, vice chairman of San Francisco brokerage Woodruff Sawyer & Co. “I think there was already an attitude for change at that point…Now you put this on top.”
The fallout from the Japanese disasters won’t bankrupt the big insurers, but it could affect earnings while they make up their capital requirements by adding to reserves, analysts say. Ace Limited, a Zurich-based insurer and reinsurer, has already released after-tax loss figures for its first quarter of up to $460 million, which includes estimated losses of $200 million to $250 million from Japan, and $210 million from the earthquakes in Christchurch, the Australian cyclone and U.S. winter storms.
Reinsurers, spurred by competition and excess capacity in the market, have underpriced their products for several years. But David Pagoumian, CEO of Napco, a New Jersey-based wholesale property brokerage, says the multiple catastrophes of 2011 could finally put a stop to falling reinsurance prices. Some even speculate that this could be the beginning of a changing market.
“A dislocation of capital of this size could lead to a hardening of the market and higher pricing,” says Guy Carpenter’s Flandro. He says the “acid tests” will come when the June 1 and July 1 renewals come up.
“I understand some of those renewals have been extended and the quotes have been pulled and are being re-priced,” Stan Loar says.
Could the Japanese crisis actually topple giants? It’s unlikely.
“If this were a $100 billion event, there would be outlier failures,” Flandro says. “But the industry could absorb them.” The biggest risk, he says, would be continued underpricing.
But, says Loar, “The standard insurance companies are going to get whacked.”
Pagoumian agrees. “The big boys are definitely going to have some issues at hand,” he says.
Most of the property damage, as well as the cost of insurance policies, will be borne by the Japanese government and private Japanese carriers. The same is true for business interruption insurance.
“There are two phases to these catastrophic losses,” Pagoumian explains. “There’s the initial capital loss and then the business interruption. In the past, we may have assessed business damages too quickly. You really have to think this through. How quickly can we get the business back up and running?”
Power outages from the damaged nuclear plants caused widespread disruption, forcing car companies such as Toyota, as well as other energy-intensive industries, such as refineries, breweries and semiconductor makers, throughout Japan to close temporarily. In turn, this created global supply-chain problems as other manufacturers and marketers across the world were unable to buy goods and parts.
Life and disability insurers in the U.S. may face some exposure as the death and injury toll grows. Most have already seen their stock prices fall as investors assess how much business companies such as Aflac, MetLife and Prudential do in Japan, where people regard life insurance as a necessity and the population is rapidly aging. Canadian insurer Manulife has warned that a weaker economic outlook in Japan would be negative for discretionary life sales, and Japan represents more than half of its Asian market.
At press time, the crisis in Japan was still unfolding. More than 3,000 were known dead and upwards of 7,000 were missing. Victims of the tsunami floated ashore or were found under tons of rubble washed in by the initial crippling wave that crashed inland for more than six miles. Because rescue workers couldn’t reach the hardest hit areas, the full extent of damage is unlikely to be known for months.
Meanwhile, the nuclear disaster created an initial 12-mile evacuation zone around the reactors, further hindering rescue and recovery efforts, and residents living even farther out were told to hide in their homes and seal them with duct tape. The final tally won’t be known until the radioactivity spewing from the crippled reactors reaches safe levels.
All of this occurred in the nation considered the modern yardstick for disaster preparation. Many are asking: If Japan couldn’t handle this, who could?
“It’s Mother Nature,” Pagoumian says. “There are just so many variables.”
So how would the larger U.S. market compare in a similar situation? Are Americans really paying attention to their own vulnerabilities, and how should they respond?
By most estimates, at least 95% of the death and damage wasn’t caused by the Japanese earthquake but the subsequent tsunami—the 30-foot wall of water that crashed into the nuclear plants, wreaking havoc on the coastal city of Sendai and crushing everything in its path for six miles inland. The scenario is eerily similar to what happened when Hurricane Katrina’s storm surge inundated New Orleans and the Gulf Coast. And it’s what could happen if the Cascadia Fault, just off the coast of Oregon and Washington, suddenly triggered a wall of water that gave residents little time to escape.
“Unlike Hawaii, there are no tsunami warnings off the Pacific Coast,” warns Julie Rochman, president and CEO of the Insurance Institute for Business & Home Safety. Nor are there any markers to tell people how high the water is likely to get, she says.
Flood insurance is a federally funded program that has been bleeding red ink since Hurricane Katrina and is now $19 billion in debt, according to the Institute for Policy Integrity.
“The simple truth is that our country is not adequately prepared for the destruction—and financial devastation—from ‘The Big One’ that strikes close to home,” says Glenn Pomeroy, chief executive of the California Earthquake Authority (CEA).
California’s chances of experiencing a major earthquake within the next 30 years are above 60% in major populated areas, according to the U.S. Geological Survey. And buildings there and throughout the U.S. will not remain standing after this kind of tremor.
“We think it won’t happen to us, and in Japan they know it will happen,” Rochman says. “California is our leading edge, and even there we are woefully inadequate.”
In Japan, she says, buildings are designed to withstand a quake. In the U.S., they just want to keep them standing long enough to get the people out. Some states don’t even do that. Illinois, she points out, doesn’t even have a statewide building code.
So it’s obvious why more insurers don’t want to jump into the earthquake market. And it’s obvious why those that do—even government entities like the CEA—keep their rates high; $800 to $1,000 is often the going yearly rate for a California home with a 15% deductible. And that’s in addition to other insurances.
“People are relaxed, and they look at the deductible,” Loar says. Many residents, he says, would rather retrofit their homes than pay the high premiums and deductibles. Businesses, on the other hand, are usually well insured for earthquakes, he says. Notwithstanding, Pagoumian says he is already getting inquiries from commercial clients seeking to examine and possibly increase their quake coverage in the wake of the Japanese disaster.
U.S. Not Prepared
If Japan is the laboratory for what happens to a major industrial nation after a disaster, there’s reason for everyone—especially insurers—to pay close attention. Fault-line fractures hide in the Mississippi Valley, loom down from the mountains in California and even run through the woods of Ramapo, N.J. Nuclear plants similar to Fukushima Daiichi abound in the Midwest, and West Coast residents live with the fear of a catastrophic crack in the San Andreas Fault. Earthquakes along any of these faults, however, would be dwarfed by the potential damage from a possible tsunami that waits right off the West Coast in what geologists call the Cascadia Subduction Zone. In the days after the Japanese earthquake and tsunami and the resulting nuclear plant failures, Californians emptied store shelves of iodine pills, a short-term solution in case leaking radiation blew across the Pacific.
After the 1994 Northridge earthquake in California, which cost 60 lives and $44 billion in damages, 33% of California homeowners were insured against earthquake risk. Today, according to the Insurance Information Institute, that figure is down to 12%.
“It is human nature to live in the moment,” Pagoumian says.
And how does that translate over to the commercial insurance business in the U.S.? It’s changing quickly, says Loar. “It’s different than it was a year ago,” he says, “and probably different than it will be in 60 days.”