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The Forgotten Disaster

Bill Kenealy November 1, 2008

While hurricanes are considerate enough to announce their intentions prior to arrival, earthquakes arrive practically unannounced. Although seismologists are able to provide general forecasts about the probability of a seismic event along a given fault line, a system accurate enough to predict a particular event in time to allow an evacuation of an at-risk area remains elusive.

"Looking at earthquake is important because it is the forgotten hazard right now," says Andy Castaldi, who is head of the Catastrophe and Perils Division at the Americas Hub for Swiss Re Americas Holdings. "What happens when we have a Katrina-like event for earthquakes?"

Fortunately, America's cities haven't endured a major earthquake since 1994, when the Northridge Earthquake struck California. Even though the quake was a relatively modest 6.7 in magnitude, it was strong enough to collapse freeways and was costly to insurers. According to numbers from the Insurance Information Institute, adjusted for inflation, the Northridge quake caused $20 billion in damage and $12.5 billion in insured losses, ranking only behind Hurricanes Katrina and Andrew as the most costly natural disaster of the past 30 years.

In addition to the losses, the Northridge quake had another major impact on the insurers as many stopped writing coverage in the state.


Andy Castaldi

The reluctance of carriers to expose themselves to earthquake risk is not just limited to California. In 2006, Northbrook, Ill.-based Allstate Corp. announced that it was dropping most earthquake coverage nationwide. One reason insurers may shy away from coverage of the risk is because the possible error bar is so large. The realm of uncertainty around the loss potential is huge, because the power of earthquakes diverges widely. For example, while a magnitude 7 quake releases 31 times the energy as magnitude 6, a magnitude 8 quake releases 1,000 times the energy of a magnitude 6.

Given the wide range of damage possibilities, precise modeling is critical for insurers as an overly conservative estimate of future catastrophe losses may price them out of the market, while an overly optimistic assessment can leave the company vulnerable to big losses should a major event occur.

"Even with Hurricane Katrina, the number of deaths was minor compared to what you'd see if you had a major earthquake in a heavily populated area," notes Alice Gannon, a senior consultant with San Diego-based EMB America LLC.

IN OR OUT

To model, carriers can create their own or, more commonly, rely on models built by firms such as Newark, Calif.-based Risk Management Solutions Inc. (RMS) or Boston-based AIR Worldwide Corp., and often run by reinsurance brokers.

Zurich-based Swiss Re, does the former, and built its own proprietary modeling tool. "Our staff includes scientists and engineers," Castaldi says. "We do some new research, but a lot of our work involves adapting existing research. We take science and transform it into applications."

Castaldi says having a homegrown modeling tool has its advantages. "It's more transparent to us because we built our own tool so we understand why it goes this way versus that way," he says. "We can open up the tool and understand why it works."


Tom Holsthouse

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