M7.3 Tokyo earthquake could cost $3 trillion in economic losses

A professor of civil engineering at Kansai University, who is also part of the Japanese government’s Central Disaster Management Council, estimates that a magnitude 7.3 earthquake beneath Tokyo could cost as much as $3 trillion dollars (300 trillion yen) in economic losses.

The new estimate from professor Yoshiaki Kawata, a recognised expert in earthquake science and the potential damages resulting from earthquakes, is roughly triple an estimate given previously by the central government, according to the Japanese newspaper The Asahi Shimbun.

The Japanese government’s Central Disaster Management Council is currently in the process of reviewing its own estimates for the potential economic damages that a major earthquake could cause in the Tokyo area. With Kawata proposing a figure so much greater than the previous government sanctioned estimate, and with Kawata a member of that team, we can expect the governments estimate to rise significantly.

Kawata simulated a magnitude 7.3 quake in the northern area of Tokyo Bay, an event which is given a 70% chance of occurring within the next 30 years, according to the data. This simulation is seen as one of the worst possible earthquake occurrences for Tokyo, so it’s not a surprise to see an estimate so large.

Kawata’s estimate suggests such an event could cause 48,000 deaths and cause economic damage, largely to buildings and infrastructure, of between 200 trillion and 300 trillion yen. Include the breakdown of political and economic activity that such a major event would cause and Kawata believes the damage could exceed $3 trillion.

Kawata also estimated that a magnitude 8.5 Sagami Trough earthquake could top the Tokyo event, with estimated economic losses of 280 trillion to 420 trillion yen (over $4 trillion) and 124,000 deaths.

These estimates were presented at a symposium on reducing damages from natural disasters held on the 20th November. The scale of the estimates is frankly terrifying, demonstrating the economic value at risk in the Japanese capital.

Any such event would be a major loss for the global reinsurance market and also most likely trigger a number of catastrophe bonds. However, earthquake insurance penetration remains low in Japan, particularly commercial, meaning that the gap between economic and insured losses would be large.

The March 2011 Great Japan Earthquake caused an economic loss of up to $300 billion it is though, but insured losses were just 12% to 17% of the total, according to data from reinsurer Swiss Re. Less than 50% of residential property insurance customers are thought to take out earthquake coverage as well, which again suggests a large gap between economic and insured losses.

Taking the upper end of Swiss Re’s estimate of 17% of economic losses being paid by the insurance and reinsurance markets, a $3 trillion economic loss event would translate to a $510 billion insurance industry loss. That number is larger than the global property catastrophe reinsurance market, which shows just how severe an event of this scale could be.

As ever, when you begin to talk about the most damaging of natural disaster scenarios the only answer to covering such enormous risks is the capital markets. If the insurance and reinsurance industry wants to grow penetration of property catastrophe re/insurance around the globe it cannot do it alone and the ILS and third-party capital sourced from capital markets investors would be essential.

Of course Japanese earthquake risk is a well-modelled peril, with a mature insurance, reinsurance and catastrophe bond market serving it. The low penetration of insurance for Japanese quake risks is a socio-economic phenomena, which one day it is expected the Japanese government will seek to increase. Without the support of the capital markets, covering such enormous loss potential would be near impossible for the reinsurance market to bear in its current form.

It has to be hoped that such a worst-case scenario never occurs, the damage and loss of life would be truly catastrophic, but the potential gap between economic and insured losses shows that there is work to be done to close it. The re/insurance and capital markets could and should provide more of the much-needed capital, for post-disaster risk financing, that events of such magnitude would require.