A catastrophe waiting to happen

In one key respect, we are better prepared than when Hurricane Katrina roared through the Gulf states. We remember all too well the fumbling among the governmental entities involved with coordinating a response to the aftermath of Katrina. Fortunately, improvements have been made that will help the various levels of government more effectively work together following the next major natural catastrophe.


 However, with respect to America’s financial ability to respond, react, and recover from the occurrence of another massive natural catastrophe, we are no better off than we were four years ago, and, indeed, are in some ways exposed to a more precarious economic condition than ever before.

Earlier this year, I conducted a study with a colleague of mine, Doug Fontaine, in which we looked at the many significant issues that hinder the traditional insurance system from providing adequate and affordable coverage for the six in 10 American families that live in areas that have sustained massive hurricanes or devastating earthquakes.

This is an area of uncertainty rife with concerns about so-called timing risk (that is, when a natural catastrophe will happen) and the unpredictability of truly massive events (for example, how much destruction they will cause). The system is affected tremendously by global capital markets that are dominated by unregulated offshore risk underwriters. It is an inexact market that balances the information garnered from computerized risk analyses, the demand for capital from competing interests in all parts of the world, and the likelihood that a completely unpredictable act of Mother Nature could strike anywhere at any time.

Anywhere: A hurricane can hit many major American cities, such as Miami, Houston, or even New Orleans again. Earthquakes could devastate cities such as San Francisco, Los Angeles, Seattle or St. Louis.

Any time: We cannot control when a major natural catastrophe hits — it could be this year, next year, or sometime far into the future.

With the knowledge that an event will happen and an understanding that some of the most densely populated and economically significant cities in America are located in vulnerable areas, policymakers at the state and federal level should be “on notice” to take steps now to prepare for these events.

Action is needed because the current system for financial preparedness is riddled with inefficiencies and there is a significant gap between the ability of the private insurance and reinsurance sectors to deal with the financial consequences of major natural catastrophes and the protection that is required.

The inability of the current system to deal with mega-catastrophes inserts the federal government into the effective role of the insurer of last resort against major catastrophes in a way that is aptly characterized as ad hoc, backward-looking and unnecessarily inefficient.

In the aftermath of an event, such as Katrina, taxpayers from every corner of America help subsidize the uninsured and under-insured losses that occur in the devastated areas to the tune of tens of billions of dollars.

There is a better way. The federal government should implement a forward-looking policy that starting today prepares us financially for the catastrophes that we know are coming. One effective policy option is contained in legislation known as the Homeowners’ Defense Act of 2009 (HDA), a bill introduced in the House and supported by then-Sen. and presidential candidate Barack ObamaBarack Hussein ObamaObama urges people to sign up for health insurance after ruling striking down law The 2020 Democratic nomination will run through the heart of black America Gillibrand says she's worried about top options in Dem 2020 poll being white men MORE.

The HDA proposes a privately funded public partnership that helps to pre-fund the financial costs of a large-scale natural catastrophe. HDA simultaneously facilitates the risk participation of the private sector, expands the availability and sustainability of the catastrophic insurance system, and provides more potent incentives for residential property owners to undertake catastrophe loss mitigation efforts. 

Our study, which was commissioned by ProtectingAmerica.org, found that this approach should add capacity, increase stability and lower costs overall. From an economic perspective, such an alliance of public and private resources best approaches the optimal manner to address the inefficiencies that plague the present system of federal disaster relief.

The type of integrated public-private partnership proposed in the HDA has the potential to expand greatly the available coverage for catastrophic events to more consumers at lower prices, while providing more stability to the insurance and reinsurance sectors (which would help alleviate the adverse shock to the U.S. economy that a major natural catastrophe could produce). According to one estimate based upon an earlier version of the HDA, direct reductions in homeowners’ insurance premiums could exceed $11 billion annually, in part by encouraging greater use of reinsurance by state catastrophe plans.

We know that another major natural catastrophe will strike. Unfortunately, there is nothing we can do to change that.  What we can do is prepare financially today for the catastrophe of tomorrow. If we don’t, we are just allowing another catastrophe — this one man-made and financial — to happen.

Orszag is senior managing director at Compass Lexecon LLC, an economic consulting firm, and former economic policy adviser on President Bill ClintonWilliam (Bill) Jefferson ClintonAlan Dershowitz: Did Michael Flynn lie? Or did the FBI act improperly? Trump will likely win reelection in 2020 Utah to impose nation's strictest DUI limit MORE’s National Economic Council.