Managing catastrophic risk: getting beyond the insurance crisis; The incidence of catastrophic risk has increased markedly, and insurance rates have risen with it. Some companies are re-examining the issue of self-insurance or even doing without and using their equity base to cover potential risks.

• Author: Millman, Gregory J.
• Position: Cover story

It probably won't come as a surprise to the average reader of the day's headlines, but statistically, the world is getting riskier--and insurance scarcer. "I think there is a crisis," says Robert Muir-Wood, chief research officer of Risk Management Solutions (RMS), one of the leading risk modeling firms.

Eighteen of the 20 costliest catastrophes since 1970 have occurred after 1990, and 10 of them after 2000. Risk modeling firms have raised their estimate for the frequency of hurricanes, and the more intense storms are increasing more than less intense storms. RMS's estimate of the loss from a 100-year storm has risen almost 50 percent, Muir-Wood says, from $70 billion to $105 billion. One reason: economic demand surge, that is, the rise in prices for materials and labor that people need to make repairs

There are also brand new sources of risk to consider. Ten of the world's 15 most deadly terrorist attacks came after 1993, and avian flu has focused new attention on the risk of a pandemic.

Not only are catastrophes happening more often, they're causing more economic damage when they do. The U.S. population continues to move to areas prone to disaster, so there are more people and assets at risk. "The five fastest-growing states are five wildfire states in the American Northwest," says James C. Schwab, senior research associate at the American Planning Association. Over half of the U.S. population lives in coastal regions, and the population density of the hurricane-prone Southeast has grown much faster than that of the nation as a whole.

Moreover, new business models that place more reliance on global supply chains suggests more economic vulnerability to catastrophes than ever before. According to the U.S. Department of State, most U.S. terrorism targets are businesses. "My concern would be that the loss of critical skill sets anywhere in the world could paralyze us from an economic and social standpoint," says Gary Lynch, global leader of Risk Intelligence Strategies and Resiliency Solutions in insurance broker Marsh Inc.'s Risk Consulting practice.

The loss of skilled engineers, capital markets decision-makers, cleared personnel in the defense industry, even the highly trained operators of cranes in container shipping ports could cripple a company and bring a supply chain, or in some cases even a whole region, to an economic halt, Lynch suggests.

Much of the new risk is not insurable. There is, for example, no insurance against a pandemic (although workers compensation could cover some of the damage). Even for traditionally insurable property and casualty risks, insurers and reinsurers are cutting capacity and raising rates.

In hurricane territory, especially Florida and the Gulf Coast, companies confront astronomical premiums for minuscule coverage amounts "In 2005, we had $1.2 billion in coverage with a $60 million deductible and paid $4.5 million in premium," says Bill Wheatley, treasurer of Florida's Memorial Healthcare System. "In 2006, we could only get $100 million in coverage, for a $100 million deductible, and were quoted $12.5 million in premium."

Memorial opted to go without coverage in 2006. It wasn't alone. Jerry McAloon, senior vice president of Aon Natural Resources, says, "As we went into the 2006 season, there was simply nowhere the capacity available at any price, as had been available in previous years, and the capacity that was available was at many multiples of what it had cost in prior years. So, most companies simply had no choice but to do without."

That sounds like bad news, but in fact it might be good news for shareholders. The new environment is forcing companies to re-think their approach to risk management. "We saw our premiums jump exponentially for property and windstorm, and retentions thrown at us that took our breath away," says John Phelps, director of risk management for Blue Cross and Blue Shield of South Florida Inc. "One of the things we learned from that was that we need to reduce our reliance on insurance as a solution."

In fact, there's a strong case to be made that, at least for larger public corporations, going without catastrophe insurance may be the best approach from a shareholder value perspective. "It's important to start out by recognizing that the corporate firm, in and of itself...