Risk Insider: Allen Melton

Are You Ready For the Big One?

By: | April 30, 2014 • 2 min read
Allen Melton is a partner and the leader of Ernst & Young LLP Insurance & Federal Claims Services Practice. He has 20+ years of experience working for both policyholders and insurers in the claims process. He can be reached at [email protected]

On March 10, 2014, a 5.1 earthquake rattled the Los Angeles area – with a 4.1 aftershock following the next day – reminding state residents of the ever-looming “big one” that California has been anticipating for many years. The quake likely caused senior management of more than a few companies to see what earthquake coverage they had in place.

It has been two decades since the Northridge earthquake shook Los Angeles, registering a 6.7 on the Richter scale and causing an estimated $42 billion in damage, and Californians are more unsettled than the ground beneath them. The most recent tremors have prompted many questions. What has changed since 1994, and how would companies and insurance markets react if another 6.7-plus earthquake struck the West Coast? According to the U.S. Geological Survey, there is a 99% chance it will happen in the next 30 years.

Learning from the past

If we have learned anything from events such as the 2013 Japanese earthquake and Superstorm Sandy, it’s that they clearly can have a significant, if not catastrophic, effect on companies well outside the “danger zone.” Over the past 20 years, markets, industries and companies have become increasingly interconnected and interdependent. The components manufacturer in Asia, for example, affects the technology company in California, which in turn affects the retailer on the East Coast.

The mega events of the past decade and a half have opened the eyes of global organizations to the need to recognize and plan contingencies for catastrophic events – even the need for a backup plan for their backup plans. In response, companies have become more sophisticated in understanding and developing their supply chains and crafting continuity plans to mitigate some of the inherent risk of operating interdependently with others in these high-hazard areas. As the world economy continues to shrink, with companies expanding globally via partnerships, joint ventures and operating agreements, the level of operating specialization and interdependency has dramatically increased, and the need for a safety net for these risks has increased in importance.

Enter the insurance carriers

The eyes – and pockets – of the insurance markets have also been opened as a result of the last 20 years of catastrophic events. This is evidenced by changes in insurance policies and endorsements available in, or eliminated from, the market.

Billions in losses resulting from storm surges after hurricanes resulted in more expansive flood exclusions. Massive earthquakes that result in large contingent losses drive more restrictive sublimits on contingent business interruption coverage. From terrorism exclusions to limits on asbestos claims, the list goes on. As insurers experience more complex losses, they become wary about the risks they take on, which affects their willingness to underwrite.

Planning for recovery

Ultimately, events like the one in Los Angeles highlight the importance of preparedness – and not just operational preparedness. It is also crucial to understand that as a business changes, expands, acquires or divests, the risks of catastrophic loss change with it. Financial recovery is a critical element of the disaster recovery plan, and one that is not always considered until after it is too late. An otherwise well-crafted plan that fails to consider the liquidity needed to implement, is not a “recovery” plan at all. Are you ready for the big one?

The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP. This material has been prepared for general information only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

Read all of Allen Melton’s Risk Insider contributions.

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The R&I Editorial Team can be reached at [email protected]