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Model to quantify volcano risk

Model to quantify volcano risk

Volcanic eruptions may be one of nature's most dramatic calamities, but there has been no catastrophe model to assess the potential insured losses.

And risk managers do not always properly consider the need for adequate volcanic risk insurance, even though disasters can cause both property and business interruption losses, experts say.

Now, however, one U.S.-based modeling firm is developing a product to calculate volcano exposures.

Risk Management Solutions Inc. in Newark, Calif., decided earlier this year to develop the industry's first probabilistic volcano risk model in the key territories of commercial interest--namely Europe, North America and Japan.

Up to now, volcano modeling has lagged other natural catastrophe models because the losses--compared with earthquakes--typically are lower, said Gordon Woo, a volcano risk expert and catastrophe risk consultant for RMS.

'Cinderella' risk

"In a way it's a Cinderella-type of risk--when it hits, then insurers will take notice," Mr. Woo said. "Most volcanoes are in areas that are not highly populated, or have little insurance cover, and therefore the insurance risk consequences are not really that great."

There are, however, some notable exceptions--one of them being Mount Vesuvius near Naples, Italy.

Vesuvius, famous for destroying the ancient city of Pompeii in A.D. 79, has been dormant since it erupted in 1944.

A Swiss Reinsurance Co. analysis in 1999, using a scenario-based approach, estimated the economic loss of another Pompeii-type eruption of Vesuvius at $35 billion--a figure that has only grown higher in the meantime.

"Vesuvius is one of those risks where everyone knows that the potential loss could be enormous if there were an event, so at the moment in terms of insurance coverage there have been some discussions of ways of transferring this risk," said Mr. Woo. He declined to give more details of such discussions, saying they were confidential.

"I think as time progresses and perhaps if we know if (Vesuvius) starts becoming more active, some of these issues will become significant with insurance deals," Mr. Woo added.

The availability of volcanic risk insurance varies from country to country, experts say.

In Italy, extended cover for volcanic eruption is normally provided only for industrial and major commercial policies that have an earthquake extension on the policy, according to Jane Toothill, a volcanologist and head of European model development for Guy Carpenter's Instrat unit, part of Guy Carpenter & Co. Ltd. in London.

The Italian government makes provision for disaster payments in its budget, she noted.

"Volcanic eruption remains a commonly neglected peril among insurers and risk managers, but volcanic eruptions are not as infrequent as commonly assumed, and the potential extent of devastation and associated social and financial impact should not be underestimated," Ms. Toothill said.

While Vesuvius is viewed as the biggest volcanic risk in Europe, there are other active volcanoes that pose economic risks, such as the Santorini volcano in Greece, the Teide volcano on Tenerife in the Canary Islands and volcanoes in Iceland that could threaten inhabited areas, experts say.

A recent eruption in Europe that caused problems was of Italy's volcano Etna in 2002. Residents of nearby Catania were exposed to volcanic ash--a health hazard--lava flows, and earthquakes associated with the eruption damaged buildings, Ms. Toothill said.

Greatest risks

Worldwide, Japan and New Zealand are countries where volcano risk is higher from an insurance perspective, noted Martin Bertogg, head of Swiss Re's earthquake group. In Europe and the United States, the frequency of eruptions affecting urbanized areas--and therefore the risk--is lower, he added. One area of risk that may be overlooked by insurers is the impact of an eruption on business interruption claims, Mr. Woo of RMS said.

For instance, while the proximity of Mount Fuji to Tokyo means the volcano would not cause physical damage, falling ash could cause major business interruption by clogging air-conditioning systems and disrupting communications, Mr. Woo said.

"That is something which I think some insurers aren't really that aware of, but it is certainly one of the major risks," he said.

As for the reasons behind developing a volcano model at this time, Mr. Woo said it was partially a consequence of Hurricane Katrina, which struck the U.S. Gulf Coast in 2005.

"With Hurricane Katrina, the situation arose where there was some unmodeled loss," namely from flooding. "Obviously, it caused a huge insurance loss and I think after Katrina, all insurers are very wary of potential risk exposures which they have and which are not modeled," Mr. Woo said.

Still, Swiss Re's Mr. Bertogg questioned the effort and resources put into modeling a risk that is so limited in nature compared to other natural catastrophes. "I am sure the insurance industry will embrace that model once it is available, but it will probably not lead to a new era of risk assessment," he said.

"Modeling has definitely one positive point," he added. "It essentially creates awareness."