Senate Homeland Security and Governmental Affairs Committee Hearing
Federal Information & News Dispatch, Inc. |
Chairman Carper, Ranking Member Coburn, distinguished Members of the
Zurich is a global insurance company providing insurance and risk management solutions to customers in 170 countries. It has been serving customers in
I would like to begin my testimony by thanking you for holding this timely hearing. I look forward to sharing with the Committee an insurance industry perspective on the current state of our nation's resilience to extreme weather events and the economic importance of investing today in improving resilience.
Zurich observes that the US is increasingly reliant on disaster recovery funding to respond to extreme weather events n1 and underinvested in resilience - physically n2 and economically n3.
Zurich maintains that insurance has a unique capacity to facilitate resilience like no other financial instrument. Insurance provides risk assessment, risk management and risk-based price signals - all of which help signal risk magnitude and risk reduction priorities to stakeholders. To reduce reliance on disaster recovery funding, increased collaboration with insurers and reliance on risk based price signals will be required because the insurance mechanism is the best indicator of risk that the market economy can provide.
Future improvements to our nation's resiliency require coordinated risk management involving the best tools government and insurers have available.
Assuring resilience to extreme weather events requires risk management before, during and after a loss event. If our response to extreme weather events is only after they occur, society has squandered its best opportunity to control risks and costs related to these events, creating an unmanaged, unbudgeted exposure.
Zurich's mission is to help our customers understand and protect themselves from risk. Our business philosophy is centered on planning for risks, and assuring the capacity and capability to respond to both the expected and unexpected extreme event. Zurich understands the importance of pre-event investments in resilience, and therefore, acts accordingly by committing time and money to support resilience initiatives for our company, our customers and the communities where we work and serve. We are very proud of our efforts and to give context, some examples of actions taken by Zurich to share knowledge with stakeholders on improving resilience of assets and of direct Zurich investments in improved resilience include:
* Since 2007, Zurich has through a formal initiative explored risk management issues relating to the role of insurance in society in providing economic resiliency, education, pre-event risk reduction and disaster management training, and post-event loss mitigation .
* In 2008, Zurich announced, as part of its global climate initiative, that it would dedicate significant resources and apply its skills in the area of risk management to assist stakeholders in adapting to and mitigating the risks of climate change. As one example of related activities, since 2011 Zurich has allowed me to accept a personal appointment to the US National Climate Assessment to share expertise and knowledge to further the understanding of the state of the science related to severe weather events and needed resilience. Many other examples exist.
* Since 2009, Zurich has been instrumental in the work of the
* In 2010, Zurich developed its
* In 2011 Zurich worked with the
* In 2012 Zurich launched its flood resilience initiative in conjunction with the
* In
* In the
* In 2013, the
* Over the years we have worked with progressive customers like
* In 2013, Zurich worked with
* Zurichhas supported the
* Zurich, through IBHS and directly in kind, has been active supporters of the
* In 2013, Zurich announced a commitment to purchase
This work and the work of the larger insurance industry on risk management techniques may provide models for closing the current resilience gap.
Roadmap to Resilience
My testimony will cover five aspects of understanding and improving our nation's resilience to extreme weather:
First, defining the extreme weather resilience gap;
Second, assessing the magnitude of the extreme weather resilience gap. Extreme Weather will cause economic disruption today and exponentially more economic disruption and other consequences in the future unless affirmative steps are taken to change this risk-accretive trajectory;
Third, the potential for the Insurance sector to provide valuable tools, skills, expertise and information, that are neither currently being effectively deployed nor leveraged to help society manage extreme weather risks and losses;
Fourth, the Federal Government has a significant ongoing role in disaster preparedness and recovery, that could be optimized through better coordination and collaboration with the insurance industry; and, finally,
Finally, the concrete steps in the short term, medium term and long term that, if taken, would begin to close the resiliency gap, including but not limited to:
* the promotion of government and private investment in infrastructure resilience;
* the development of government policies and programs that send risk-based price signals;
* the elimination of government policies and programs that distort insurance markets;
* the education of society on the true costs of extreme weather events and the personal and community economic benefits of improved resilience; and
* the promotion and enforcement of stronger building codes.
Point 1: There is an extreme weather resilience gap
Currently in
Irrespective of which definition is applied, in the case of extreme weather events, significant assets and communities in
One only need read the newspapers to affirm that in the face of named storms and other extreme events, large numbers of assets, and the communities that are defined by these assets and which support them, are not sufficiently resilient. Current risk management systems,-engineering tools, land use policies, public and private insurance uptake and or disaster aid are not sufficient to incentivize or create asset resilience nor to facilitate rapid restoration of the asset and resiliency after an extreme weather event. Impacts of catastrophes, especially economic impacts, are not limited to single structures, dwellings or families, but are rather impacting entire communities and regions.
Look to the
"...Our main results are that major natural catastrophes have large and significant negative effects on economic activity, both on impact and over the longer run. However, it is mainly the uninsured losses that drive the subsequent macroeconomic cost, whereas sufficiently insured events are inconsequential in terms of foregone output. This result helps to disentangle conflicting findings in the literature, and puts the focus on risk transfer mechanisms to help mitigate the macroeconomic costs of natural catastrophes." (emphasis added)
A recent economics research paper confirmed through analysis that droughts and floods slow economic growth, thus affirming the importance of investment in resilience to extreme weather events. The European Commission Environment for Science newsletter summarized the report findings as follows:
"Droughts and floods can significantly damage economic growth, recent research has found. A 1% increase in the area affected by drought can slow a country's gross domestic product (GDP) growth by 2.7% per year and a 1% increase in the area experiencing extreme rainfall can reduce GDP growth by 1.8%, according to the study.
Investments in water security could help reduce this negative economic impact, say the researchers." n11
Point 2: The magnitude of the resilience gap is sufficient to cause short, medium and long term economic disruption today and more so in the future unless affirmative steps are taken to change this risk-accretive trajectory
The resilience gap is large. How large? In 2010, Professor Cummins and co-authors projected that costs for the federal government share of unfunded disaster response costs for weather related disasters would grow to amounts within the range of the unfunded social security benefits over the same time horizon of 75 years: unfunded social security benefits are estimated to be approximately
Unfunded exposures of the state catastrophe funds are in addition to this number n14. The magnitude of state exposure from state natural catastrophe funds was estimated by the Government Accounting Office in a 20120 report at about $3T USD n15
Another recent report found that both the frequency and magnitude of federal disaster relief for events causing loss in excess of
The US Government Accountability Office has also found these exposures to be of sufficient magnitude to warrant inclusion in the High Risk Series n17.
Munich Re NatCatSERVICE data show that the number of loss-relevant weather catastrophes has increased significantly since 1980, globally and in
While taxpayers are bearing the burden of this increasingly unbudgeted risk and associated loss costs, some experts have suggested that the current approach to disaster funding may be unintentionally creating a 'stealth entitlement' n22. From an insurers' perspective, this would manifest as an inhibitor for demand for our risk management products and services - a market distortion.
Without decisive risk reduction and management action by those tasked with managing risk - local, state and federal governments, as well as insurers, economically unsustainable accretive unbudgeted disaster management costs are projected to n23 continue on an upward trajectory.
This is not a concern unique to
"... Even where costs of major disasters are locally concentrated, if costs are inadequately covered by insurance then individual Member States may carry large fiscal burdens, which could cause internal and external imbalances." Noting further at page 12, section 3.0 "...Building resilience is a long-term effort that needs to be integrated in national policies and planning: resilience strategies are also part of the development process and contribute to different long-term policies, in particular climate change adaptation and food security."
The pattern of extreme weather event frequency and severity is predictable according to academics and other experts; and this science forms the basis for our industry's natural catastrophe modeling and underwriting processes. These predictive modeling processes are today the backbone of the underwriting standards for natural catastrophe and allow insurers to properly price risk. In addition to forming the foundation for pricing insured risk, the science related to extreme weather events suggests that a foundation for budgeting for resilience investments with a better return on investment might be defined from this predictable cash flow demand, as I discuss further
Point 3: Insurance has valuable data and analysis, tools and expertise that when leveraged to their greatest efficient capacity can help society manage these extreme weather risks and losses; disaster recovery funding is not a functional equivalent to insurance for these characteristics
The fundamental function of insurance is risk pooling. Insurance also provides a number of other critical functions that benefit individuals and society: risk assessment, risk management and risk pricing; and general social welfare value through security n26. Today, insurance is not being fully leveraged to solve the unfunded severe weather resilience gap.
For example, insurers use risk assessment, risk management and risk pricing data to inform customers about risks, consequences and options for resilience investments so they can take action to protect their assets. One of many examples of this service is the offering of Strategic Risk Management Solutions (SRM) by Zurich for its customers in 2008 n27. Part of SRM services includes the Total Risk Profile (TRP) tool which applies a risk identification methodology - in advance of loss to predict potential exposures and identify mitigation options . SRM even quantifies the risk so you can prioritize budget spending to fix the most impactful issues. Zurich applied SRM TRP post-Sandy for a food supplier. Application of the TRP tool revealed that there was only one route through which a large portion of NYC food passes and the impact magnitude of the route interruption was great, so alternative route development proceeded to mitigate risk. Local governments and individual citizens may not have access to such information and may default to dependency on disaster recovery money rather than loss avoidance or mitigation through advance planning or investment.
Some may believe that ex-post disaster recovery funding takes the place of insurance. Ex-post disaster recovery funding is neither equivalent in function nor speed to private insurance n28. One of the critical differences is that disaster recovery funds typically are delivered more slowly than insurance payments. The result is a slower recovery and even longer term negative economic impacts n29.
Trends suggest some in society are now shunning private insurance because of the expected availability of government-funded disaster relief. The uninsured and underinsured are deciding to rely on perceptively lower cost ex-post financed disaster recovery mechanisms - but with concomitant lower economic functionality. This trend includes state and local governments in addition to individuals n30.
This trend does not support economic resilience in the face of extreme events. In fact uninsured and underinsured economies are more likely to suffer long term macro-economic damage n31. The financial reality of this ill-advised short term expense trade (e.g. avoiding premium payments) is long term negative economic productivity impacts n32. Whether the asset owner has chosen public insurance with artificially capitated limits or disaster recovery mechanisms in lieu of private insurance, the impact of this choice does not often 'hit home', so to speak, until disaster strikes n33.
A recent report prepared by the
(1) homeowners, renters and small business owners need to understand the importance of purchasing flood insurance. There also needs to be greater education about what is and is not covered under a flood insurance policy;
(2) There was widespread confusion on the role of deductibles in an insurance policy and even more misunderstanding regarding wind and hurricane deductibles;
(3) Homeowners and renters did not understand their overall coverage and their various insurance options;
(4) Claimants need to have a better understanding of how the claims process works before there is a disaster; and
(5) Some businesses did not understand their coverages either.
The above -cited report notes that individuals did not understand what was insured, uninsured and / or how disaster response funds might be available - or not - to help their personal recovery n35.
Disaster aid is prioritized to address government function and services first; private assets are addressed as a secondary priority at best.
By contrast, insurance is a contract agreement governed by its terms, conditions and applicable law focused on the individual insured and their assets. Insurance is an on-going business, structured with ex-ante funds with a consistent administration in constant operation and procedures to assure efficient and timely administration to meet its obligations.
Disaster aid is generally episodic, unplanned and dependent upon ex-post special appropriations. Disaster aid must be distributed through a system which may be designed ex-ante but which is only activated ex-post on an infrequent basis leading to concomitant start up delays.
The key strategic question is two-fold - can insurance play a role in accelerating the transition of insufficiently resilient-state assets to assets that meet underwriting criteria AND provide a stable, predictable, affordable risk management tool to society on a long-term basis?
Traditional insurance theory and proved applications suggest the answer is yes .
However, for insurance to play a substantial role in improving societal resilience to extreme weather events the following conditions must be in place: deployment of insurance must occur through collaborative public-private partnerships which address moral hazard mitigation and stem uncontrollable risk accretion by retaining the function of risk-based price signals to incentivize risk reduction on the part of risk creators.
Where net present value (NPV) mitigation investment opportunities exist with private insurance, deploying insurance would have ex post welfare enhancement value. n36 As one example, Zurich's work with
A major complication in assessing the welfare value of insurance is the interaction between four factors - increasing severity of the catastrophes, the rising trend of governmental aid, the substitution of government insurance for private insurance and the incentive of homeowners and the government itself not to mitigate n37.
The real world value of the risk reduction incentive created by the ex ante insurance approach is significantly greater than the pure short-term cost efficiency offered by an ex post financing theory because it addresses what economists call moral hazard n38.
Thus, by their very nature, private insurance and government sponsored disaster aid are different. Neither the power of private insurance nor government sponsored disaster aid can be fully leveraged in isolation. Maximum leverage of these resources arises only in cases of partnership and collaboration n39. This public-private partnership as discussed below is the only way to leverage both activities to achieve long term, consistent resilience in the face of natural catastrophe, especially as exacerbated by climate change.
Point 4: Government has a current and ongoing role in disaster preparedness and recovery that could be significantly enhanced through better collaboration with the insurance industry;
Government has an important and ongoing role in both disaster preparedness and disaster recovery. However, preparedness includes investments in pre-loss mitigation and regulation incentivizing prudent risk management behaviors on the part of communities.
Government should provide a systematic approach to risk reduction through national and regional plans that coordinate multiple stakeholders to bring about the necessary solutions n40. Such plans need to be enabled by appropriate legislative and administrative frameworks which:
* Encourage and facilitate greater investment in pre-loss mitigation and improved infrastructure resilience;
* Promote and support transparent risk-based price signals;
* Address disadvantaged or at risk population with vouchers rather than hidden cross subsidy n41;
* Promote and enable national minimum building codes and standards by conditioning federal matching funds on resiliency criteria;
* Clearly communicate priorities and limitations of disaster response and recovery so that citizens can make educated decisions about insurance and other risk management decision taking. n42
Current trends and studies suggest that more pre-loss mitigation expenditure would improve the return on the taxpayer investment in catastrophe-prone areas.
Governmental policies also need to be adjusted to achieve these ends. For example, building codes must be adjusted to be responsive to the extreme weather exposures of today and those projected for the future, consistent with the expected useful life of the asset to be built or remodeled. This would assure that new and modified building stock was resilient during its expected useful life (upon which society relies for many economic calculations) and would leave only pre-existing building stock and assets as potentially inadequately resilient.
Such pre-loss mitigation expenses are exceptionally cost efficient providing a minimum of a 4:1 return on investment n43.
Insurance also can be leveraged to promote resilience in building. Insurers can require that assets be repaired or rebuilt after a loss event to the new sufficiently resilient building code. This approach "smooths in resilience" and assures that when the next extreme weather event strikes that the assets and communities are more resilient and less likely to experience repeat losses. This breaking of the cycle benefits residents, communities, governments, and business.
Point 5: There are immediate short term, medium term and long term actions that should be taken to close the resiliency gap, including but not limited to the promotion and enforcement of stronger building codes; promotion of investment in resilience; and support for and requirement of risk-based price signals.
Should resilience investment be prioritized over disaster response costs ?
Absolutely. Why ?
Investment in Resilience:
1. Saves Taxpayers billions of dollars annually - this a cost effective investment that will save local, state and federal governments billions of dollars.
2. Provides greater protection to the public in the face of increasing extreme weather events, reducing human suffering.
3. Reduces business interruption and overall economic impacts of extreme weather events; and
4. Creates domestic jobs and promotes domestic manufacturing in building more resilient housing and infrastructure
Studies affirm the value of pre-loss risk mitigation investment in reducing extreme weather and climate-related risk. In fact, one study claims a conservative 4:1 return on investment for risk mitigation (adaptation) investments n44. Others have estimated a greater than 10 to 1 return so even 10% would be extremely valuable. Assuming the investments could ensure long term resilience, avoided losses should be discernible within a budget cycle reflecting the return rate of extreme events after completion of the first projects whether those projects are bricks and mortar or policy reforms - noting that the implementation of policy reforms may actually take longer in some cases than brick and mortar projects.
What should be done to improve resilience?
First, government could provide a systematic approach to risk reduction through national and regional plans that coordinate multiple stakeholders to bring about the necessary solutions n45. Adoption of a non-proprietary tool like the proprietary Zurich Total Risk Profile Tool would be beneficial. Before risk reduction strategy can be developed, a national priority plan must be developed. Much research about asset vulnerability exists, but a framework in which to evaluate and prioritize it does not. Development of this risk reduction prioritization framework, perhaps through the GAO may be a good vehicle for this.
Actions
1. Use the language of the Extreme Weather Title of the Water Resources Development Act as an example of what could be applied to improve the resilience requirements framing the hundreds of billions of dollars the federal government invests annually in water, port, highway, transit and aviation infrastructure.
2. Expand the
Simultaneously, private and community resources should supply information on what individuals and communities can do to improve resilience. Regionally targeted assessments should be made to assess resilience of community, and resilience fact sheets should be prepared and distributed to insufficiently resilient populations. Given the combination of recent trends in drought and wildfire and the continued migration of greater populations to the wilderness urban interface (WUI), the need for this action will become increasingly urgent over time.
This information already exists in some cases, but in many cases it must be developed. Insurers have some information but by no means all if the information necessary to assess resilience needs and alternatives. Further, insurers do not develop this knowledge as part of their current business operations as many of these risks are not assumed by private insurers, but have been assumed by the government either through government insurance programs or by default as a disaster response provider.
Economic resources to perform such vulnerability assessments and for related responsive capital investments in resilience might be derived from the amount of special appropriations predicted by Cummins. It is also logical to take a portion of that predictable special appropriations demand and use it to improve resilience in assets.
How much should be budgeted?
From a practical perspective, funding resilience is a fundamentally wiser investment than spending on disaster relief and recovery. As previously noted, the
Theoretically the determination of the appropriate amount for investment in resiliency should be based upon a technical assessment of a local and regional basis of vulnerability to extreme weather events, current resiliency conditions for vulnerable assets, and prioritization using a cost / benefit analysis framework. But, in the end, the amount of vulnerability that can be reduced will be bounded by the practical reality of the federal budget - and prioritization will need to be made with a temporal component.
Immediate, concrete and responsible actions, including increased capital investment in resilience is essential to maintain economic sustainability in the face of extreme weather events and climate change.
Conclusion
ZURICH believes that we have an opportunity to dramatically improve the resilience of our nation's homes, businesses and critical infrastructure and that this can be achieved in a manner that will ultimately save federal, state and local governments billions of dollars annually while providing citizens greater protection from extreme weather events. Seizing this opportunity will require:
* Extensive collaboration between the insurance industry and the federal government to provide needed incentives for improved resilience;
* Elimination of government policies and programs at the federal, state and local levels that provide perverse disincentives to improved resilience;
* Investment by local, state, and federal governments in enhanced infrastructure resilience measures;
* Investment by businesses and homeowners in enhanced resilience measures
On the ground behavioral changes, shaped by government policies, in conjunction with increased investment in resilience and risk management must occur in order reverse the current trajectory of unbudgeted federal disaster expenditures. .
I hope my testimony has provided the Committee with a greater understanding of:
(1) the economic value Zurich sees in resilience investments;
(2) why Zurich believes more investments in improved resilience should be made today across regions of the nation with assets and people at elevated risk to extreme weather events; and
(3) how Zurich thinks investments in improved resilience might be balanced with funding for disaster relief and recovery to maximize the economic impact of finite federal funds.
Zurich is extremely encouraged by the Committee's efforts to improve resilience and develop sustainable communities in the face of extreme weather events. Zurich looks forward to working with the bipartisan leadership of the Committee to perfect the innovative climate change adaptation tools of the future.
n1 "Federal Financial Exposure to Natural Catastrophe Risk"
n2 http://www.infrastructurereportcard.org/a/browser-options/downloads/2013-Report-Card.pdf
n3 Id Cummins and BIS Working PapersNo 394 , Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes by
n4 The latest Global Risk Report can be found at http://www.weforum.org/reports/global-risks-2014-report; "the Global Risks 2014 report highlights how global risks are not only interconnected, but also have systemic impacts. To manage global risks effectively and build resilience to their impacts, better efforts are needed to understand, measure and foresee the evolution of interdependencies between risks, supplementing traditional risk-management tools with new concepts designed for uncertain environments "
n5
n7 https://www.disastersafety.org/resiliencestar
n8 http://www.zurich.com/media/newsreleases/2013/2013-1118-01.htm
n9 Appropriations request post Katrina Emergency Supplemental Appropriations for Hurricane Katrina Relief
n10 BIS Working Papers No 394 , Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes by
n11 http://ec.europa.eu/environment/integration/research/newsalert/pdf/359na1.pdf citing
n12. "Federal Financial Exposure to Natural Catastrophe Risk"
n13 Id. Cummins page 62 at para 3
n14 Id. Cummins (2010) page 62 para. 3.
n15 Reports citing Citing GAO-10-568R Natural Catastrophe Insurance Coverage GAO 2010 at http://www.hawaiireporter.com/hurricane-sandy-pacific-tsunami-scare-expose-state-catastrophe-debts/123; http://www.statebudgetsolutions.org/blog/detail/hurricane-sandy-tsunami-scare-expose-state-catastrophe-debts
n16 "Disastrous Spending: Federal Disaster-Relief Expenditures Rise Amid More Extreme Weather",
n17 See GAO-13-283 High-Risk Series
n18
n19 Id. at 19, Figure 3.
n20 Id. at 22.
n21 Id. at 19.
n22 For a longer discussion on the concept of 'stealth entitlement' and natural catastrophe response costs, see "Federal Financial Exposure to Natural Catastrophe Risk,"
n23 "Federal Financial Exposure to Natural Catastrophe Risk"
n24 EUROPEAN COMMISSION Strasbourg,
n25 https://connect.innovateuk.org/web/oasis-open-access-catastrophe-model.
n26 Zurich Role of Insurance in Society and Economic Development http://zdownload.zurich.com/main/reports/What_is_the_role_of_economic_developement.pdf; http://www.zurich.com/internet/main/SiteCollectionDocuments/insight/social-and-economic-value.pdf
n27 See Appendix 1 Zurich SRM brochure.
n28 BIS Working Papers No 394 , Unmitigated disasters? New evidence on the macroeconomic cost of natural catastrophes by
n29 Id
n30
n31 Id. BIS
n32 Id. BIS
n33 http://www.wnyc.org/articles/wnyc-news/2013/apr/30/sandy-damage-prompts-some-to-walk-away-instead-of-stay/ ; http://news.yahoo.com/six-months-hurricane-sandy-much-still-175600302.html; and Id BIS.
n34 http://www.iii.org/assets/docs/pdf/Sandy-042413.pdf.
n35 http://www.iii.org/assets/docs/pdf/Sandy-042413.pdf.
n36 Jaffe,
n37 Jaffe,
n38 BIS working paper 394; "A Vision for Managing Natural Disaster Risk,
n39 "A Vision for Managing Natural Disaster Risk",
n40 Id.
n41 "Addressing Affordability in the National Flood Insurance Program", Issue Brief,
n42 http://www.iii.org/assets/docs/pdf/Sandy-042413.pdf.
n43
n44
n45 "A Vision for Managing Natural Disaster Risk,
n46 "Disastrous Spending: Federal Disaster-Relief Expenditures Rise Amid More Extreme Weather",
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