Capital markets can help reform America’s approach to disaster risk

As the economic costs of natural disasters in the U.S. rises, so to does the financial burden on the Federal Government, leaving the country’s natural disaster policies in need of reform, according to coalition organisation SmarterSafer.

SmarterSafer, an organisation focused on financially sound, national disaster policies and methodology has published a new report, titled, “Bracing for the Storm, How To Reform U.S. Disaster Risk Policy To Prepare For A Riskier Future,” highlighting several detrimental impacts of the country’s current natural catastrophe policies and signalling an opportunity for the capital markets to become more involved with U.S. disaster risk.

The report states that current policies focus too heavily on recovery efforts instead of preparation and prevention measures.

An approach that has also negatively impacted America’s National Flood Insurance Program (NFIP), which is currently in $23 billion worth of debt.

Issues that SmarterSafer believes are exacerbated by the increasing use of federal, or the taxpayers money to fund post-event recovery efforts, something the report says “reduces individual and community incentives to invest in mitigation and makes it less likely homeowners and businesses will insure their property for disaster.”

SmarterSafer reveals that the share of disaster recovery spending by the state has increased from 23% after Hurricane Hugo (1989), to a staggering 80% in the wake of Hurricane Sandy (2012).

That’s quite a jump, and something the report attributes in part to the Stafford Act, which ensures the U.S. government is accountable for at least 75% of costs once an event has been declared a disaster.

The study argues that current measures and policies “needlessly expose Americans to greater risks to life and property and results in much higher costs to the federal government.”

A key theme of the report is mitigation and an urgent need for disaster resources to focus on “presponse” (essentially pre-event risk transfer) ensuring wiser, fairer and efficient use of disaster designated funds, which in the long-term SmarterSafer feels will save the government money.

According to the report, a study from 2007 revealed that every $1 the state spent on disaster mitigation resulted in an average saving of $4, rising to $5 to $1 for flood mitigation investment.

In order for things to change the study identifies five vital elements of U.S. disaster risk management that must be reformed; Encourage planning and mitigation, fortify infrastructure, reform flood insurance, ensure equity and improve coordination.

While the report signals mitigation as the key driver for reform, it discusses how re/insurance, catastrophe bonds and alike can alleviate some of the infrastructure recovery costs borne by the government.

“Explore the use of private-sector financial tools such as insurance and catastrophe bonds to shield publicly owned infrastructure from catastrophic, taxpayer-funded liabilities in case of disaster,” urges the report.

A valid point, particularly when the current reinsurance sector is loaded with alternative and traditional reinsurance capital, waiting to be deployed through innovative, needed risk transfer and disaster relief tools.

An example of this can be seen with New York’s Metropolitan Transport Authority explains the report.

By utilising its own insurance company, “which covers the first $25 million of property damage caused by a disaster as well as up to $1 billion in losses from reinsurers,” the organisation takes on the costs typically fronted by the government, something more entities in more states should consider, says the report.

The same authority also issued its own $200 million cat bond in 2013, again showing how the capital markets can successfully play a deeper role in U.S. disaster risk.

Another area the insurance-linked securities (ILS), re/insurance and wider capital market tools can aid the U.S. disaster sector is with the NFIP.

Currently in debt of around $23 billion, the rise in severity and frequency of hurricane and flood events across the states has seen the program face high-level losses, with debt expected to climb as catastrophe losses significantly outweigh premium income.

A trend worsened by the fact that “the total insured value of coastal residential and commercial property was $10.6 trillion in 2012, up from $8.9 trillion in 2007, a 20% increase in just five years,” according to data from AIR Worldwide, notes the report.

To ensure the NFIP’s debt stops rising the report calls for competition from the private sector, something catastrophe bonds, insurance, reinsurance and the broader capital markets are extremely capable of.

While mitigation is clearly the aim of SmarterSafer, and rightly so, it’s apparent that a heightened use of risk transfer mechanisms to protect against U.S. disasters would greatly alleviate some of the financial stress it puts on the state.

While enabling broader, cheaper and more effective coverage to the most vulnerable regions of the country, it would also release some of the capital currently sitting in the space.