Waiting in the wings: high-impact, low-probability catastrophes, such as meteorite crashes and giant tsunamis, are changing from "what ifs" to realities for insurers. (Cover Story).

The tragedy of Sept. 11 has changed how insurers view the future. The terrorist attacks have forced insurers to ponder previously unthinkable loss scenarios. "Insurers have known about supernatural catastrophes for a while but considered them events so great that nothing could be done about them or that they would be highly unlikely to occur. But since Sept. 11, insurers are expecting the unexpected. It's a change in thinking to what other things can happen that we haven't thought of," said Bill McGuire, professor of geophysical hazards and director at the Benfield Greig Hazard Research Center, University College London.

Insurers are adding volcanic super-eruptions, giant tsunamis, effects of global warming and hits by meteorites and asteroids to their list of potential loss scenarios. Underwriters and actuaries are projecting the possible effects if another storm the strength of Hurricane Andrew hit Miami directly or the equivalent of another North-ridge earthquake shook the center of Los Angeles. They even are considering the worst loss scenarios--the combination of a major terrorist attack and natural catastrophe occurring within the same quarter or year.

New Thinking

International insurer Swiss Re reported that although the industry has always considered terrorism in its underwriting, Sept. 11 exposed a previously inconceivable scale of threat scenarios and loss potentials. As a result, "in order to minimize the overall risk, above all for insurers operating on a worldwide scale, it is necessary to document as fully as possible the loss scenarios that have been hitherto underestimated or unidentified," Munich Re stated in its 2001 disaster report.

Munich Re also predicted the number of $1 billion losses will continue to climb. Since 1983, 34 natural catastrophes have caused insured losses of $1 billion, and 32 of them had natural causes. More losses of that magnitude will occur around the world due to growing population in vulnerable areas combined with the threat of more intense weather.

McGuire believes insurers must take a "clear horizon" approach to identify and quantify risks before they happen, making sure to include low-frequency but high-impact events. "The last few years have seen a growing awareness of such shadowy phenomena as asteroid and comet impacts, volcanic super-eruptions and giant tsunamis, which have now become, as it were, respectable--passing from the rather airy-fairy realm of science fiction to the cold, hard world of hazard science," McGuire said.

Global Warming 

As fossil fuels are burned worldwide, carbon dioxide is emitted into the atmosphere and acts like a blanket that keeps the normal infrared emissions from leaving Earth. This causes Earth's temperature to rise. The issue among scientists isn't whether global warming exists, but what its effects will be on Earth, said Greg Smestad, professor in the Program in International Environmental Policy, IEP Graduate School of International Policy Studies in the Monterey Institute of International Studies.

Smestad pointed to reports from the U.S. government's National Oceanic and Atmospheric Association and the United Nations' Intergovernmental Panel on Climate Change that indicate that Earth's temperature is rising, as the global average surface temperature has increased during the 20th century by about 0.6 degrees Celsius. In a recent report, the IPCC stated that it's virtually a certainty that the 1990s was the warmest decade. The panel also found that satellite images show it's very likely that snow cover on Earth has decreased 10% since the 1960s. The IPCC report points to anthropogenic, or man-made, sources as the cause of the warming. Carbon dioxide has gone from 280 parts per million in the atmosphere before the Industrial Revolution to more than 370 ppm and is rising exponentially, Smestad said.

"Climate and [CO.sub.2] have changed in the past and will change in the future. What concerns scientists is that it's changing faster now than in the past 10,000 years. The adaptation to the change also worries them, and insurers should be worrying, too," Smestad said.

Where scientists disagree is how the change will play out environmentally. They know a warmer Earth will allow more water vapor into the atmosphere; what they don't know is where and how the built-up heat will dissipate. According to Munich Re, the risks from global warming include a worldwide increase in heavy rains, hailstorms, floods, heat waves, a probable increase in the frequency and intensity of storm activity in central Europe and tropical cyclones popping up in new areas.

It's going to be very difficult to correct the global-warming problem, experts say. Because carbon dioxide is being emitted by such a wide variety of sources-transportation, residential and commercial sectors--it will be challenging to regulate and change policy. "It's not a question of not driving SUVs or building more efficient homes; it also includes less polluting by corporations," Smestad said.

Thomas Drennen, another expert on economic and environmental issues, said cuffing dependence on fossil fuels would change how the global economy is driven. Pointing to the Kyoto Protocol, which set targets in 1997 for reduction of greenhouse gas emissions by major industrialized countries, Drennen said the goals set for the next decade are unattainable. According to a computer model used to calculate what it would take to reach the reductions pledged, the United States would have to eliminate using all coal, natural gas and oil to generate electricity in the next 10 years. Drennen, an assistant professor of economics at Hobart and William Smith Colleges, has worked with federal poilcymakers on the United States' role in the Kyoto Protocol and had previously thought it was a viable solution. "It's a flawed treaty, and it can't be reached in the next 10 years without destroying our economy," Drennen said.

Even if the United States and other industrialized nations meet their Kyoto goals, China and India are a big question mark. China, with an estimated 1.2 billion people, is rapidly becoming a part of the global market. As the Chinese become more successful economically, the number of cars will increase--today, there are only three cars for every 1000 people--and that will add to the global warming problem. "Global warming is not a local problem; it's a global problem," said Drennen.

Munich Re also pointed out that even if the Kyoto Protocol is implemented, the world would have to contend with weather-related catastrophes resulting from climate change for decades to come. "In view of the loss trends that can be observed, the conventional practice of retrospective underwriting--involving calculating premiums from the claims development of the past--inevitably leads to premium adjustments lagging behind and to losses increasing. The effects of climate change make adequate prospective underwriting more essential than ever," said Wolf-Otto Bauer, member of the board of management for Munich Re.

Not So Fast

A recent Tillinghast-Towers Perrin study shows that scientists' fears of more catastrophic hurricanes are unfounded. "Our study put historical hurricane costs on a comparable level. No one had ever measured the whole 20th century before or considered the explosive growth of residences and vacation homes near the coast," said Tillinghast Principal Doug Collins.

Collins adjusted historical U.S. hurricane losses from the conditions at the time of each event to those existing today. By adjusting actual hurricane damage to reflect current property values and the increase in the number of people living near the coast, Collins discovered insured damages in the 1990s were not unusually high compared with other decades in the 20th century. The results also show that Hurricane Andrew did not produce the highest adjusted damages from a single storm. That distinction belongs to the September 1926 Miami hurricane that tallied $50 billion in insured damages, on an inflation-adjusted basis, compared with Andrew's $25 billion. "The results were surprising that there wasn't an upward trend in damages. Because there has been so much talk of global warming and scientists have been presenting evidence that the temperature has risen, there's been speculation there would be more hurricanes," Collins said.

The catastrophe expert working for the Alliance of American Insurers said global warming is a political creation used to promote restrictions on emissions standards more than a proven theory. Hugh Strawn, who works for the alliance's sister organization, the Property Loss Research Bureau, contends that the global-warming theory is based on data that is only 100 years old and that it is an infinitesimal period of time compared with the age of Earth. The bureau believes any slight warming could be just a natural change that has occurred before in history.

Volcanoes and Tsunamis

In his book, A Guide to the End of the World: Everything You Never Wanted to Know, McGuire of University College London brings attention to the threat of volcanoes to global business. A volcanologist, McGuire points out that only a few hundred of the world's 3,000 active volcanoes are currently being monitored. Right in the United States' Yellowstone Park is the best studied super-eruption source, after producing three blasts over the past 2 million years.

Super-Size Threats

When volcanoes erupt, the magnitude is measured on the Volcanic Explosivity Index, which indicates the violence of the eruption. The most explosive and destructive volcanic activity is a super-eruption, as it is capable of causing drastic changes in the climate. According to McGuire, the last super-eruption, 650,000 years ago, caused volcanic debris 20 centimeters deep to accumulate 1,500 kilometers away in what is now El Paso, Texas, and Los Angeles. Although a similar eruption would affect the U.S. economy severely, the Yellowstone volcano is monitored, and any signs of a super-eruption would be detected years in advance. McGuire pointed to the unmonitored volcanoes in the southern Andes and Southeast Asia as a potential source of risk for insurers.

Insurers also face the threat of losses from a future giant tsunami. Caused by the collapse of volcanic ocean islands, one is indeed waiting in the wings. On the Canary Island of La Palma, a rock the size of the Isle of Man has been sliding seaward since 1949, McGuire said. A recent model shows the rock hitting the ocean in as soon as 100 years or taking thousands of years. But if the Cumbre Vieja volcano on La Palma erupts, it will hasten the rock's dropping into the ocean. The massive wave initially would be 1 mile high, according to McGuire, shrinking to 150 feet high when it hits the east coast of the United States and Caribbean Islands. The real bad news is that the Spanish government has stopped paying for monitoring the volcano, McGuire said.

Visitors from Outer Space

Considering the impact of meteorites, comets and asteroids, developing a risk-management plan in case one of them hits Earth is a prudent action, according to Munich Re. The difficult part is convincing insurers and corporations that such occurrences are normal, if infrequent, behavior in geological terms, McGuire said.

About 150,000 asteroids orbit in a belt between Mars and Jupiter. In 1932, an asteroid took an elongated orbit and passed close to Earth. Munich Re reported that since then about 1,500 near-miss asteroids have been discovered. One of the most famous hits from space debris took place in Tungaska, Siberia, in 1908. Scientists estimate a meteorite about 60 meters wide vaporized in an explosion that left no crater but felled about 60 million trees within an area of 2,200 square kilometers, roughly the equivalent in land mass to the cities of Berlin, Moscow and London. The explosion was so great that village inhabitants 300 miles away from the site reported a deafening explosion.

Even though every day about 100 tons of dust and small pebbles tumble to Earth's atmosphere from outer space, it would take an object about 1 meter to 1.5 meters to cause mass destruction. Scientists estimate that this size impact occurs once every 100,000 to 300,000 years. "An impact of this size would wipe out a city, and the insurance industry would be hammered. The costs would run in the trillions, because the impact would create explosions thousands of times more powerful than a nuclear bomb," McGuire said.

Other risks caused by incoming meteorites include heat waves caused by the friction of the hurtling object with the atmosphere, and earthquakes and climate change as the meteorite strikes Earth and creates a crater that causes rock vapor to rise to the sky, creating dust clouds.

In terms of insured coverage, Munich Re reported that a distinction must be made between all-risk and named-peril covers. Under an insurance contract for all-risk covers, no event is specified, so coverage exists. In the case of named-peril coverage, Munich Re advised the wording unmanned flying objects" be defined as to whether they have to be manufactured or caused by nature. Wording should also be crafted in the contract to define whether "flying objects" have a ballistic or aerodynamic trajectory or could they be considered a flying object if they just fell directly down from the sky. Munich Re said while losses caused by meteorites hitting Earth are mostly covered under standard policies, with the exception of pure-impact and pressure-wave losses, if a meteorite does hit a major metropolitan area it would cause unprecedented losses. Insurers should have plans in place to handle even this unlikely scenario, Munich Re said. Simply pointing to the presumable rarity of such events should no longer suffice in the light of recent experience, the global insurer said.

McGuire advised insurers to work with international institutions to mitigate and minimize the impact if one of the natural catastrophes strikes. This includes crafting a financial plan that will help societies to get back on their feet after suffering a tremendous natural disaster. "The point to make is it's certain they will happen again. These natural catastrophes have always happened on Earth and are considered completely normal behavior. Insurers can't exist on their own. Together with financial institutions they have to work together to come up with a solution. At the moment it's important just to get them aware of these things," McGuire said.

RELATED ARTICLE: Polluted Water Can Trigger Insurance Claims

Water makes up 71% of Earth's surface, but less than 1% of the world's fresh water is accessible for direct human use. Compound that with the world's constantly increasing population, the trend to live in already-crowded metropolitan areas and the enormous amount of water needed for agriculture and manufacturing, and its clear that safe, clean water will be an issue for years to come.

Swiss Re already is considering the insurance risk of polluted water, citing drivers such as man-made climate change and the increasing use of chemicals in medicine and manufacturing. The manufacture of something as simple as a soccer shirt for example, can use a multitude of chemicals that raise the risk of polluting the water and air. With more than 100,000 chemicals used in production of the world's good today, the threat that some of them will pollute a company's hand and cause the site to lose economic value is growing larger every day, said Thomas Streiff, head of sustainability managemnet for Swiss Re. The mission of sustainability is to identify ecological and political changes and to the prepared with risk-management techniques and new products.

Water quality is an inherent risk that can have a huge Impact on property, liability and health issues. Streiff said. It also is an important component to product liability coverage, especially for industries such as beverage manufacturers that depend on a public water supply for their operations. In May 2000, for example, the public water supply in Walkerton, Ontario, became contaminated by E. coli , causing more than 2,300 people to become ill.

Swiss Re is evaluating its clients' dependence on water and developing risk-management strategies. If a client is dependent on water, the insurer helps the company develop new strategies to cut use in exchange for lower premiums. Swiss Re's purpose is not only to be perceived as a credible knowledge center, but also to be part of the solution for its clients, Streiff said.