Hi, I’m Carl Tannenbaum, Chief Economist for Northern Trust.

The Southern California fires earlier this year were horrific to watch. Sadly, the tragedy is only the latest in an intensifying string of natural disasters that have afflicted many millions around the world.

Amid such devastation, economic considerations aren’t the first things that come to mind.  But viewed through that lens, we have example of what is known as “the broken window fallacy.” Forecasters typically raise their estimates of construction spending in affected areas, which is perversely positive for growth. But an offset will come in the reaction of insurance companies, which will be immensely costly to residents of California and beyond.

According to Munich Re, hurricanes, fires and other weather-related events caused $320 billion in damages worldwide last year.  Insurance companies are consequently re-evaluating the pricing and availability of policies offered to homeowners and businesses in especially vulnerable areas.

In the United States, the impact of this has been most pronounced on the coasts. Florida has been stricken by 80 named storms this century, ten of which were considered major.  California has been spared from hurricanes, but fires have claimed millions of acres and thousands of homes. 

In the wake of increasing claims, insurance carriers increased their premiums.  When states were reluctant to approve them, carriers left. A study by the California Association of Realtors found that nearly one in three homeowners in the state experienced difficulty obtaining insurance coverage…and this was before the January fires.

Rebuilding after a disaster cannot proceed without securing insurance, which is typically a requisite for obtaining a home mortgage.  New policies may contain higher deductibles or limits on coverage that may not satisfy loan underwriters. Both California and Florida have tried to help by forming state insurance pools, but those systems are now insolvent. They will need to be recapitalized by increasing premiums paid by local residents.

Whether near to disaster areas or far away, citizens pay some of the costs.  Relief funds are routinely appropriated by the Federal government, using tax receipts.  Coverage premiums rise for homeowners everywhere, as carriers seek to reprice risk and rebuild their capital.  The destruction of critical infrastructure will require substantial amounts of public investment.

Recent events offer a window into what might lie ahead if the frequency and severity of tragedies continues to increase.  The insurance system surrounding vulnerable areas is broken; it needs to be rebuilt in a way that can weather any storm.

And that’s the view from here.