Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [23]
With increasing urbanization and the concentration of social and economic activities in high-risk areas, costs of catastrophes will continue to increase. The development of Florida highlights this point. According to the U.S. Bureau of the Census, the population of Florida has increased significantly over the past fifty years: 2.8 million inhabitants in 1950, 6.8 million in 1970, 13 million in 1990, and more than 19 million projected for 2010 (a 600 percent increase since 1950). The likelihood of severe economic and insured losses will escalate as well, unless cost-effective mitigation measures are implemented. Today, insured assets worth no less than $2.4 trillion are located on the coasts of Florida alone; if one takes into account the coasts ranging from Texas to Maine, the figure jumps to more than $8 trillion. We are sitting on a ticking bomb. The question is not whether other large-scale catastrophes will occur but when and how frequently they will strike, and how extensive will be the damage they cause.
This wider variance in level of risk also creates new business opportunities. Catastrophe bonds, also known as “cat bonds”—financial instruments that transfer catastrophe exposure to investors on the financial markets—quickly developed in the aftermath of the 2005 hurricane season in the United States. For instance, it is possible for a company not to use insurance itself but to sell $100 million of exposure to an earthquake of magnitude 6.0 or above to investors on the markets. If nothing happens or the earthquake is below this threshold, investors keep the premiums paid by the company; if an earthquake of higher magnitude occurs, investors have to indemnify the company. Doing so allows diversification of the risk beyond the traditional insurance and reinsurance markets. Between 1996 and 2008, over 100 cat bonds were issued—57 between 2005 and 2007 alone, as a response to increases in reinsurance prices in the aftermath of Hurricane Katrina. The take-away here is that as catastrophes unfold, businesses should start thinking about not only how to protect their assets but also what new products and services could be developed in this new environment.
Feature 2: Confusing Distribution of the Roles and Responsibilities of the Public and Private Sectors
In considering almost all of the catastrophes that have occurred during the past decade, we find it nearly impossible to dissociate the economics of catastrophe management from politics. One measure of this confusing distribution of roles lies in the lack of pre-established and publicly known rules as to who should pay what amount to victims of disasters: Insurance? State government? Federal government? The upward trend in the number of U.S. presidential disaster declarations between 1953 and 2008 (as depicted in Figure 5.2) is illustrative. This trend raises the obvious question as to what are the key drivers of such presidential decisions and whether some states are more likely to benefit than others.
FIGURE 5.2 U.S. Disaster Presidential Declarations Per Year
Sources: Author’s calculation with data for the U.S. Department of Homeland Security. Note: Peak values on the graph correspond to some presidential election years in the United States.
It is interesting to note that many of the peak disaster years correspond to presidential election years. This is consistent with recent research showing that election years are very active times for disaster assistance (all other things being equal). Four salient examples are the Alaska earthquake in 1964, Tropical Storm Agnes in June 1972, Hurricane Andrew in September 1992, and the series of four hurricanes in 2004. Then, during 2008, another election year, no fewer than seventy-five disaster declarations were issued—the historical high point. In other words, with catastrophes come