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Thursday, September 8, 2011

Financing Recovery After a Catastrophic Earthquake or Nuclear Power Incident

Rawle O. King
Specialist in Financial Economics and Risk Assessment

On August 23, 2011, a rare, powerful magnitude 5.8 earthquake and aftershocks hit Mineral, VA, shutting down two North Anna Power Plants located about 7 miles from the earthquake’s epicenter. The earthquake was felt from Georgia to southeast Canada. Other earthquakes have also occurred in the area, as well as in surrounding areas. For example, on July 16, 2010, a 3.6 magnitude earthquake occurred in Gaithersburg, MD, about 110 miles from the epicenter. Seismologists report that although Virginia is classified as a “moderate” seismic risk zone, since 1977, the state has experienced 160 earthquakes, of which just 16% were felt. According to the U.S. Geological Survey (USGS), this earthquake was the strongest earthquake to hit the entire states since the 5.8 magnitude tremor in 1897.

Separately, on March 11, 2011, a massive 9.0 magnitude earthquake struck off the coast of Honshu, Japan. It was the most severe and likely the costliest earthquake to hit Japan in the 130 years of recorded history. The Japan earthquake and tsunami caused more than 10,000 casualties, widespread property and infrastructure damage, blackouts, fire, and nuclear meltdowns. The nuclear crisis has compounded the challenges faced by a nation struggling to clean up and recover from the earthquake and tsunami. Two weeks later, the disaster triggered a crisis at the nuclear power facility; Japan’s government said there was a leaking reactor core at the Fukushima Daiichi nuclear reactor complex, releasing radioactive contamination into the atmosphere and groundwater.

In the aftermath of the recent East Coast earthquake (and shut down of the North Anna nuclear power plants) and Japan’s technological and natural disaster, U.S. policymakers are asking if it could happen here and, if so, how associated costs would be financed. In the event of a major natural disaster, several catastrophe risk financing and insurance issues could arise, including (1) the need to revisit the nature, extent, and timing of potential earthquake and tsunami hazards in the United States; (2) the adequacy of nuclear third-party liability insurance capacity; and (3) the challenges of financing recovery from natural disasters and making earthquake insurance more affordable. The latter challenge is largely a function of the national financial markets’ capacity to absorb the cost and economic burden of a devastating mega-earthquake.

Given the economic devastation in Japan, there is heightened congressional interest in finding ways to reduce disaster risk for homeowners, insurance companies, financial firms, and both federal and state governments. This report examines earthquake catastrophe risk and insurance in the United States in light of recent developments. It examines both traditional and non-traditional approaches for financing recovery from earthquake losses as well as challenges in financing catastrophe losses with insurance. The report also explores the feasibility of a federal residential earthquake insurance mechanism and assesses policy implications of such a program. Finally, the report examines legislation introduced in the 112
th Congress that addresses issues related to earthquakes, including S. 637, the Earthquake Insurance Affordability Act. S. 637 would authorize the U.S. Treasury to guarantee up to $5 billion in bonds available to certified public entities, like the California Earthquake Authority (CEA), following a catastrophic seismic event. The entity would have to exhaust its claims-paying ability before the federal guarantee becomes available. The measure is designed to reduce earthquake insurance rates by reducing the need to purchase reinsurance. The bonds would be repaid with premiums.

Date of Report: August 2
5, 2011
Number of Pages:
Order Number: R4196
Price: $29.95

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