More than a month after Hurricane Irene narrowly missed making landfall on Wall Street and pummeled the East Coast with floods, the effects of the storm continue rippling outwards. Congress narrowly avoided a government shutdown over a bitter dispute over FEMA funding after a summer of disasters had drained its accounts. Meanwhile, insurers are potentially facing $5.5 billion in losses, not counting flood damage (which isn’t covered under most homeowner policies) or economic losses stemming from power outages and destroyed roads or rail.
That isn’t much to sweat about for an insurance (and reinsurance) industry reeling from $70 billion in losses stemming from the Japan and Christchurch earthquakes. But like the Japanese quake—which raised the specter of the "Big One" under Tokyo—Irene came close to being the Big One of hurricanes with a direct hit on Lower Manhattan. The prospect of billions upon billions of dollars in physical and economic damages from a single storm is enough to make one wonder whether we should stop building on the coasts altogether.
That’s the scenario hedge fund manager and catastrophe bond pioneer John Seo had in mind when he predicted in the current issue of Foreign Policy that "a decade and a half from now, a single hurricane or earthquake will come with a potential price tag of $1 trillion or more. Imagine a world in which economic damage equivalent to that caused by a major war or the detonation of a midsized nuclear weapon in a major city could materialize with a warning of only a few days."
The numbers back him up. According to a 2008 study of the world’s largest port cities by the OECD, 40 million people are at risk of flooding, and total economic exposure is $3 trillion, about 5% of global GDP. By 2070 those numbers are expected to rise to 150 million people and $35 trillion, or 9% of GDP. Most of that growth will occur in Asia, where a major typhoon rolled through the Philippines and shut down Hong Kong’s financial markets this week before making landfall on China’s Hainan Island.
The prospect of a single storm practically bankrupting their industry has not been lost on insurers or their odds-makers. In June, Risk Management Solutions received permission from Florida regulators to update the risk models insurers use to set policy prices. The new models increased Florida’s potential hurricane losses by 6.5%, with damages in inland areas soaring as high as 90%. As Reuters dryly noted, "analysts say that the U.S. model changes could give insurers a strong incentive to raise prices."
But raise them to what? Because not only is the potential for destruction increasing, but so are the frequency and intensity of storms as well. A study released earlier this month by Ceres, a consortium of public interest groups, found that by and large insurers believe in climate change—and believe it will increase their losses. Allstate CEO Thomas J. Wilson recently told analysts the company is saying goodbye to the "good old days" and is now "running our business as if this change [in extreme weather] is permanent."
If that’s the case, just how long until large chunks of America’s coastline become virtually uninsurable, starting with Lower Manhattan? Some would say this is a good thing, a perfect example of markets appropriately pricing risk and (dis-)incentivizing people accordingly. One of them is Matthew Kahn, an economist at UCLA and the author of Climatopolis: How Our Cities Will Thrive in the Hotter Future.
"A big issue in social sciences right now is how people process low probability events," he says. "Climate change raises the probability of a catastrophic storm from one in ten thousand to one in a thousand. The insurance companies could be our leading indicator of this change. We have to allow them to "price gouge," because are they gouging, or are they pricing new risk?"
Kahn favors using a combination of zoning and uncapped insurance premiums to steer people and business away from flood-prone areas, including Lower Manhattan. The alternative is innovative engineering schemes such as London’s Thames Flood Barrier, opened in 1984 to withstand a one-in-a-thousand-year storm, or Singapore’s $230 million Marina Barrage. It remains to be seen whether a trillion-dollar storm arrives in a thousand years or the next decade.
Where would they go, those unfortunate enough to be priced out of their uninsurable homes in the era of climate change? Kahn favors a soon-to-be-more temperate Rust Belt, e.g. Buffalo, Cleveland, and Detroit. "The "New Detroit" of 2050 will have a warmer winter and be at relatively little risk of flooding," he writes. His UCLA colleague Laurence Smith goes further in The World In 2050, predicting the rise of "The New North" around the Arctic Circle, in which the big winners are Toronto, Calgary, Minneapolis, and Moscow. There’s definitely less of a need for flood insurance in Saskatoon.
Read more stories like this in our series, the Butterfly Effect