Managing the escalating risks of natural catastrophes in the United States

Since the early 1990s, total economic losses from natural catastrophes in the US have averaged tens of billions of dollars per year. These disasters cause death and injury, damage property and the natural environment, interrupt business activities, and disrupt society generally. Furthermore, owing to trade and other commercial activities, the impact of these natural catastrophes often extends well beyond the immediate disaster area to other regions within the US and even to other nations.

Damages from natural catastrophes in the US are rising and are expected to continue to grow in the future. Increases in population and economic activity coupled with development in riskier and more environmentally vulnerable areas, will expose more property, infrastructure and other assets to damage from natural catastrophes. Inflation, recovering property values and increasing individual wealth may further amplify the potential costs of damages. Whatever the cause, it is evident that we are experiencing more frequent extreme weather events.

Many individuals and organisations have a vested interest in managing natural catastrophe risks. Property owners (both private and real estate interests), the insurance industry and the government all have a role to play. Property owners have an interest in managing risks to their property and/or investments. The business of the insurance industry is to help property owners manage risk by transferring it from an individual policyholder to a larger risk sharing community with premiums set to represent an insured's contribution to the overall risk. Government participates through its regulation of the insurance industry and when its involvement is necessary to correct environmental externalities, support risk mitigation or subsidise damage claims for the common good of society.

The increasing vulnerability arising from more people, economic activity and infrastructure in high risk areas, coupled with increasing evidence that climate change is leading to more frequent and severe weather events, points to continuing increased natural catastrophe risk on a scale not experienced before. Because of the scope and long-term nature of the problem, collaboration and cooperation among the key stakeholders identified above will be essential.

Often the private natural catastrophe insurance market is unable to function properly where, for public policy reasons, government-run insurance programmes or pools offer insurance that does not reflect the true price of the risk. Insurance is not sustainable if it is offered at rates below what is required by sound, risk-based actuarial practices. When insurance is not risk-based, the wrong price signals are sent and there is little or no incentive
to mitigate risk. In turn, this leads to wider adverse impacts on society, such as degradation of vulnerable environments and a reliance on emergency funds to help rebuild communities after catastrophic events.

Lloyd's plays an important role in the US natural catastrophe market, helping protect individuals and businesses from natural disasters and enabling companies and communities to recover and rebuild after severe events. In this paper Lloyd's sets out a set of principles for addressing the challenge of managing natural catastrophe risks in the US. Within these principles and the accompanying report, we examine ways that the insurance industry, government and property owners can work together to manage increasing natural catastrophe risks and make insurance in catastrophe-exposed areas more available and affordable for US policyholders.