By DAN REYNOLDS, senior editor of Risk & Insurance®
The risk management puzzle is changing due to the rapidly morphing global climate and a worldwide economic engine that is at once increasingly connected and increasingly fragile; that much we know.
What we also know is that the sheer number of global catastrophes and their cost are growing at rates never seen before. Consider these statistics, gleaned from a late 2008 paper by Erwann O. Michel-Kerjan, a professor in the Wharton School of Business at the Philadelphia-based University of Pennsylvania.
Michel-Kerjan pointed out that the 20 most costly insured catastrophes in the world in the past 38 years all occurred since 1987. Of those 20, he advised, half of them have occurred since 2001, and nine of those 10 have occurred in the United States.
"It's no wonder that new business opportunities around catastrophes are proliferating," Michel-Kerjan wrote.
There are opportunities, yes, but Michel-Kerjan seems to be of the opinion that current methods for quantifying risk are inadequate. What's needed, he argued in his 10-pager paper, "Toward a New Risk Architecture: Welcome to Risk Management 2.0," is a new way to describe the world of risk and its elements.
His "new architecture" as he described it, has six different features that, if woven together correctly by an astute risk manager, might comprise a more modern understanding of risk. We don't have space to get into each set here, but a quick glance at the first two might help illuminate what Michel-Kerjan is up to.
His first feature, "Extreme Costs, Extreme Benefits," described just how much more costly catastropheshave become and, on the bright side, outlined the business opportunities that cost has created.
"It might be difficult to imagine that when Hurricane Hugo hit the country in 1989, it was the first catastrophe to inflict more than $1 billion in losses," Michel-Kerjan wrote. He contrasted that to Katrina's cost of 1,300 lives and total damages estimated to be in the range of $150 billion. Increasing development in Florida, which has seen its population increase from 2.8 million inhabitants in 1950 to a projected 19.3 million in 2010, can only increase the cost of catastrophe.
But Michel-Kerjan pointed out that catastrophe bonds have emerged and grown as a corresponding investment opportunity. The use of CAT bonds grew from $4.7 billion issued in 2006 to $7.1 billion issued for natural disasters alone in 2007, Michel-Kerjan documented.
Michel-Kerjan's second of the six features of his new architecture is entitled "Confusing Distribution of the Roles and Responsibilities of the Public and Private Sector." The private sector owns 85 percent of this country's critical services, yet when disaster strikes, most people surveyed on the street think the government should respond.
One striking detail in Michel-Kerjan's consideration of the role of the public and private sectors in disaster remuneration is the fact that most, but not all, presidential election years correspond with peaks in the presidential declarations of disasters.
"This obviously raises the question of what are the key drivers of such a presidential decision and whether some states are more likely to benefit from such situations than others, and if so, when does this occur?" Michel-Kerjan wrote.
It also seems to point out that as a culture, we are becoming increasingly dependent on government aid, not less so. Catch a link to the rest of Michel-Kerjan's study on our Web site.
April 15, 2009
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