Kobe: An Expensive Lesson in Different Approaches

As vast as the costs will be, not to mention the terrible loss of life, the Kobe earthquake’s global economic effects will be relatively slight--and subtle.

There will be lessons and pointers for the U.S. economy, but no great impact on world markets or commerce. In fact, insurers worldwide will see the results from Kobe as validating their new approach to risk assessment.

That’s why stocks of major insurance companies, including American International Group, Chubb Group and others with operations in Japan, rose most of last week even as earthquake news came in.

There were fears also that Japan would have to call home overseas investments to pay for rebuilding infrastructure in Kobe and Osaka, but that won’t be the case. Even if total damages approach $100 billion, “that’s not a lot compared to the size of the Japanese capital markets,” says a Wall Street expert.

In total damages, Kobe will turn out to be far more expensive than the Northridge earthquake or Hurricane Andrew in 1992. But insured losses probably will be less than either of those disasters because the Japanese government limits insurance losses to $7.5 billion for private insurers and $7.5 billion for the government’s Earthquake Reinsurance Co., a pool of money collected from companies by the state.

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Also the government insures most residential property in Japan and major companies insure themselves--meaning they pay damage costs when they occur instead of paying premiums to insure against losses.

That Japanese example will spur calls for the U.S. government to set up a similar catastrophe insurance fund. But Americans will be less enthusiastic when they learn that Japanese homeowners can look forward to receiving only 30% of the value of their damaged property from the government’s insurance.

In any event, the U.S political climate doesn’t favor new government programs, even though insurance companies, mortgage lenders and homeowners support the idea of a catastrophe fund. “There won’t be a fund,” predicts Joanne Morrissey, head of Firemark Research, a Parsippany, N.J. insurance consulting firm. “In the U.S. we act as if another disaster won’t happen.”

Not really. The Japanese and U.S. approaches to insurance reflect different societies. Here government disaster relief serves as a backstop to private insurance, which is affordable with a high deductible--when companies offer it. But Americans, a demanding people, expect to receive a high percentage of the property’s value if a claim is necessary.

In Japan, earthquake insurance is very expensive, many people don’t have it and there is a general recognition that property owners bear damage losses in earthquakes. It’s not so much fatalistic as realistic.

On the other hand, the Japanese government and neighboring communities were slow and disorganized in getting help to the earthquake area--a marked contrast to the swift response of U.S. and local government agencies to the Northridge quake. Unaccustomed protests from people in Kobe and other towns said that it sometimes pays to be demanding.

One certain result of the quake is that both Japanese and U.S. engineers will restudy ways to make buildings and roadways resistant to tremors. “They’ll be trying to come up with new building methods and materials, and the insurance industry will be very interested in that,” says Gary Ransom of Conning & Co., a Hartford, Conn., insurance investment firm.

There will be a lot of rebuilding in Kobe and Osaka--initial estimates project $45 billion in construction. That will give a boost to Japan’s lagging economy, just as rebuilding after Northridge gave Los Angeles’ economy a transfusion last year.

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But reconstruction that fires up idle capacity in Japan, allowing its economy to grow 3% rather than 2%, won’t increase global inflation or long-term interest rates. (The Federal Reserve is still likely to hike U.S. short term rates next month, but rates on the long-term funds that finance world business are unlikely to rise, say experts).

And claims settlements in Japan won’t raise insurance premiums around the world--mainly because premiums are already high. Natural disasters in recent years have resulted in historically unprecedented losses, causing some insurance companies to go out of business.

So the global insurance industry has changed the way it calculates risk, reports analyst Norman Rosenthal of Morgan Stanley. “Rather than rely on historical experience, the industry now calculates risk exposure,” says Rosenthal--what it will cost in tomorrow’s dollars, adjusted for inflation, to replace the structure being insured. Rates are higher but insurance is more secure.

In fact, new companies have sprung up in the field of reinsurance--names like Mid Ocean Reinsurance, which has backing from J.P. Morgan & Co., and La Salle Reinsurance, backed by Chicago insurer Aon Corp. These are expert international companies to which local and regional companies pass on their highest levels of risk, just as major medical policies back up standard coverage.

The new reinsurers, many of them based in Bermuda, have brought $5 billion in fresh capital to the global insurance pool that stands behind coverage of ships and airliners, commercial buildings and ordinary residential real estate. They are not fazed by the claims that will emerge from Kobe. “Japanese insurance buyers are good customers,” says Michael O’Halloran, managing director of La Salle Reinsurance, “We’ll pay claims promptly and look forward to doing business there tomorrow.”

And undoubtedly that spirit, of looking forward to doing business tomorrow, will carry Kobe and Japan through this disaster as it has others.