Nobody is going to be ready when a Category 5 hurricane slams into Southeast Florida, flattens Miami, bankrupts insurance companies, threatens a foreclosure crisis, and sends financial shockwaves across the world.
The catastrophe, if it comes, will first manifest as just a natural disaster. Floridians will flee the impending hurricane, emptying neighborhoods and clogging freeways. Some will stay in their homes, confident this hurricane will be no worse than previous years’ storms, while a smaller minority might be persuaded by far-right talk show hosts the whole thing is a left-wing conspiracy. Entire swathes of the state will be destroyed. People will die. But what comes next will be even more shocking. The storm’s financial aftermath could spiral outwards from Florida, creating conditions that inevitably draw comparisons to the 2008 Wall Street crash.
The conventional wisdom is that a scenario like this is so unlikely to occur that it’s almost not worth discussing. The odds of a worst-case hurricane making landfall in Florida in any given year is low, insurance companies have sophisticated strategies for mitigating risk, and the financial system by and large is insulated from physically destructive events. (Even 9/11, for instance, caused a stock market downturn that only lasted a month.)
Yet in recent weeks VICE spoke with financial, political and scientific experts—including a former special assistant to President Barack Obama, the dean of science of a major Canadian university, and a UK organization on the global vanguard of disaster modeling—who believe that conventional wisdom has its limits. Without wanting to be seen as alarmists by overstating dangers, these experts think it’s crucial that we question and challenge common assumptions around financial risk.
They point out that a warmer climate is making hurricanes more severe and destructive. Above-average temperatures are increasing the rainfall of tropical cyclones between 5 to 10 percent, while rising seas add to the intensity of flooding.
At the same time, there are structural aspects of the insurance industry that are more opaque and perhaps riskier than the public thinks, creating the potential for localized financial damage from a massive hurricane to quickly spread internationally, a process similar to what happened during the subprime mortgage crisis in 2008.
Though even the worst physical disasters have had little impact historically on global markets, there is reason to believe that above a certain financial (and even psychological) threshold, natural catastrophes can weaken economies and ultimately lead to damaging recessions. Given all that, the experts VICE spoke with think it’s reasonable to wonder whether society is massively underestimating the economic dangers posed by rising global temperatures.
This has disturbing implications for all cities on the front lines of extreme weather, and Southeast Florida in particular. It could mean, under a specific set of conditions, that Miami is a ticking financial time bomb waiting any day now to be detonated by climate change.
One version of a worst-case hurricane for Florida is a storm that makes landfall just south of Miami, heads slightly inland, then moves steadily up the east coast. This is the scenario of maximum devastation, explained Shahid Hamid, a finance professor at Florida International University’s International Hurricane Research Center, because part of the hurricane will be able to draw heat from the ocean while slamming Miami, Fort Lauderdale, Palm Beach, Melbourne, Jacksonville, and Orlando with the strongest possible winds. “The hurricane is basically buzzsawing through the cities,” Hamid said.
If this were to happen, it could also create a ten-foot storm surge that demolishes homes and blocks the streets with debris. “South Florida is not remotely prepared for a Category 3 or higher hurricane,” Bryan Norcross, who was a TV meteorologist in Miami during Hurricane Andrew, which killed 65 people in 1992, warned the Washington Post in 2017. “People will be stuck in buildings with no power, no water, likely little or no communications, and no way to get out or get people in with supplies and aid for an extended time after the storm.”
Hamid thinks “the probability is very low” of this ever happening. But he added that the scenario almost became real in 2017. “When I saw the track of [Hurricane] Irma that was being predicted, two to three days out, it looked similar to the track of our worst-case scenario.” Irma killed dozens of people as it ripped through the Caribbean, but mellowed as it approached Florida. “Fortunately the hurricane weakened and moved west to the less populated areas,” Hamid said. Over 60 percent of homes in Florida lost power and ten people died. Still, he added, “We dodged a bullet.”
This time we may not be so lucky.
When Hurricane Andrew made landfall in Florida it destroyed over 125,000 homes and caused $26.5 billion in damage. To this day it’s still considered one of the most destructive hurricanes ever. But the value of coastal property in Florida has grown from $870 billion to more than $3.7 trillion in the intervening years.
When today’s worst-case hurricane lands in Miami it could cause $150 billion of insured losses, according to Hamid’s estimates. That only includes wind damage to people’s homes, not to structures like strip malls and office buildings, nor flooding losses from a storm surge. In 2015, Boston-based catastrophe modelers Karen Clark and Company projected insured damage losses from a massive hurricane striking Miami directly at $250 billion. But even that number could be low.
Last year, the Centre for Risk Studies at Cambridge University’s Judge Business School modelled a slightly different catastrophe than the one described by Hamid. In this one, a Category 4 hurricane first makes landfall in Florida Bay, slightly south of Miami, with 147 MPH winds. It then heads northwest, blasting Tampa, crossing the Gulf of Mexico, and making a second landfall as a Category 3 hurricane near Pensacola. In this scenario most of Florida’s coastal airports and seaports experience heavy damage. “Further exacerbated by port closures, national import and export rates fall by approximately 5% within a fortnight of the disaster,” writes the Centre for Risk Studies. It takes two years to fully rebuild everyone’s homes. The total physical damage exceeds $1.35 trillion.
This is an important threshold. “In disasters we commonly see today… you’ve got losses in the hundreds of billions of dollars,” Oliver Carpenter, a research assistant at the centre who studies natural catastrophes and the global economy, told VICE.
As financial fallout from the disaster spreads from Florida it may put $2.35 trillion of world GDP at risk.
The 2017 Atlantic hurricane season for example caused $282 billion in damage. “That’s relatively fickle in the grand scheme of things,” he argued. For reference, about $169 billion was traded each day on the New York Stock Exchange as of 2013. Hurricane Katrina, which caused $125 billion in losses and may have had a total economic cost of $250 billion, had a negligible impact on financial markets even as it caused massive amounts of human misery and death. Based on historical experience, it’s reasonable to conclude that even the most destructive catastrophes pose relatively little risk to the wider economy.
But damage over $1 trillion may challenge that logic. “That’s the threshold when these losses have a noticeable impact and spread to the global economy,” Carpenter explained. The Centre for Risk Studies estimated someone with a high quality investment portfolio could see a 6 percent drop in returns following the worst-case Miami hurricane. As financial fallout from the disaster spreads from Florida it may put $2.35 trillion of world GDP at risk.
Though this likely wouldn’t cause a recession, “the weakened economies that result would be more vulnerable to any other shocks that could occur coincidentally during the recovery period and make a recession more likely,” the centre’s study reads while discussing catastrophic natural disasters in general.
It adds that this is “thought to be towards the upper end of current scientific constraints, but it is plausible that even larger magnitude events could occur.”
A storm of this size may have dire impacts for insurers. Hamid estimates Florida’s private insurers have the capacity to pay about $60 billion in claims following a major catastrophe. A Category 5 hurricane demolishing Miami is “way beyond the capacity of the insurance companies,” Hamid argued. “Some of the companies certainly will go under.”
That $60 billion safety net includes something called reinsurance, or insurance for insurers. Knowing that an unexpected disaster could drive them bankrupt, insurers pay companies such as Munich Reinsurance Company or Berkshire Hathaway to take on some of the risk.
These reinsurers also don’t want to be on the hook for a disaster. So they trade financial risk among themselves in the “retrocession” market. “It’s a complicated market and it’s very opaque,” said Matt Davison, the dean of science at Ontario’s Western University and co-author of a 2016 Bank of Canada paper looking at systemic risk in reinsurance. “Sometimes risks are traded, and then traded again, and then traded again in complicated layers and even the people trading them are no longer quite exactly sure which risk they’re buying.”
As long as losses don’t exceed a certain threshold, the system spreads and dampens financial risk. “But what we wanted to look at is, ‘What happens if one company in the chain fails?’” he said.
The trigger may be a disaster—or, more likely, a series of them—more costly than anything in recent human history. “There are relatively few such potential events,” Davison's paper argues, “although one such might be a Miami hurricane.” In the aftermath, a reinsurance company could receive a gigantic claim from an insurance company it has trouble paying.
“Something like that happens,” Davison said, “it weakens [reinsurance] Company A. At the same time, Company A is believing it’s going to get a big check from Company B through the retrocession market, and it doesn’t, because Company B is bankrupt. Now Company A is even weaker, it goes down. Now [Company A’s] contracts with Company C are in question. And the whole thing spins out of control.”
This is similar to what happened in the financial crash of 2008. Risky mortgages were bundled into “collateralized debt obligations” and traded on financial markets. “[It] led to financial products that were thought to be very safe, they turned out to be not safe at all,” Davidson said. “In some ways the retrocession market has some formal similarities on a financial structure basis.”
Davison is quick to add that this on its own doesn’t mean the reinsurance sector is unsafe. Under most circumstances the trading of risk helps prevent a spiraling crisis: “I don’t want to be alarmist here and say, ‘Oh wow there’s going to be another financial crisis coming from insurance.’ I don’t believe that’s the case.” For a Florida hurricane to pose systemic risk to the sector, “there kind of needs to be a uniquely bad constellation of events,” he said.
Yet we’re moving into an era of extreme weather that’s challenging our ability to assess and manage risk. A paper published last year in the academic journal Nature Climate Change noted that warmer atmospheric temperatures are causing multiple stresses at once on our natural and social systems.
In 2018, for instance, heat waves and drought in California led to the worst wildfires in state history and the bankruptcy of utility company PG&E. That same year, Hurricane Michael became likely the strongest hurricane to hit Florida—and the US—since Hurricane Andrew. Disasters will become more interlinked and harder to predict, leading one of the paper’s authors to describe a future that’s “like a terror movie that is real.”
But it’s an open debate whether the insurance industry—or the wider financial system—actually faces any near-term risk from climate disaster. Daniel Schwarcz a University of Minnesota law professor and insurance expert who’s testified before US congressional committees, told VICE “most of the risk of climate change really isn’t being held by insurers right now.”
Policies for property damage are renewed annually. “Insurers are only exposed for the next year and they’ve survived things like Katrina,” he noted. “There could be some terrible storms in a given year and frankly they could really hit the industry hard but they can always recalibrate.”
Insurers can leave risky markets or raise prices. “They understand that there’s massive risk associated with climate,” Schwarcz said. “They’re not taking it on.”
That strategy has worked fine in the past. But Moody’s Investor Service argued last year that climate change is challenging long-held assumptions. “Risk modeling and pricing will experience an extra layer of uncertainty since climate change tends to produce an unpredictable environment that makes assessing and pricing risk more difficult,” it wrote. Despite that warning, Berkshire Hathaway CEO Warren Buffett told Yahoo Finance in 2018 that climate change is “not really an insurance risk.”
In an ideal world, the insurance industry would help us adapt to a warming planet by informing the public of risks. Insurers determine the likelihood of disasters using catastrophe models. The cost of those disasters is then factored into insurance rates, and when rates rise high enough, towns and cities relocate away from high-risk areas, or at least they should.
That’s not what’s happening in Florida, which in recent years has seen a record-setting coastal real-estate boom, even as the risk of flooding and hurricanes intensifies. In 2017, for example, a Florida developer sold over $300 million worth of units in a building called the Bristol, making it the most expensive condo development in Palm Beach County history. Though the boom shows signs of slowing down, there are currently homes worth a combined $6.4 trillion at risk of flooding in Miami Beach alone.
None of this would likely be possible without state subsidies that reduce the price of insurance and expose Florida to huge financial risk. If a series of weather events devastates Florida, “losses could leave the state in a financially awkward position,” wrote storm risk expert Lorilee Medders in 2017. “The state would virtually be forced to tax the business and tourism base more heavily to make up the shortfall—a risky option. In some worst-worst case scenarios, Florida could face wide-scale population emigration, sustaining a heavy loss of its tax base.”
Michael Wara, a lawyer and research fellow at Stanford’s Steyer-Taylor Center for Energy Policy and Finance, explained to VICE in January that if this comes to pass, “You could easily see the state of Florida go bankrupt.”
This increases pressure for a bailout from the federal government. One form the bailout could come in is through a huge payout of claims from the National Flood Insurance Program, which insures 1.7 million Florida households against flood disasters. Even though the federal program is in over $20 billion of debt, it’d be extremely difficult to deny aid to people suffering in the wake of a catastrophe. “It’s just too hard for political leaders to say, ‘No, we’re going to stand firm in our fiscal beliefs and not get help to our constituents,” said Alice Hill, a former special assistant to President Barack Obama and a research fellow at Stanford’s Hoover Institution.
Even with a federal government bailout, a severe enough hurricane could cause a psychological tipping point for developers, insurers, realtors, buyers, and investors who decide it’s just too risky to stay in Florida. “What we want to prevent is that canary in the coal mine effect where insurance companies pull out of the Miami market, which could have a catastrophic economic impact even before the climactic events,” Miami Mayor Francis Suarez said in February.
Alternately, homeowners who face skyrocketing insurance costs in the wake of a disaster may walk away from their mortgages, threatening a foreclosure crisis. “When I was in the White House, there was talk of how much do we really want [these risks] to be widely known?” Hill said. “You could have a sudden fall in the market prices without a hurricane. It could be just a mass realization that all of this property is severely compromised. That would be highly destabilizing to real estate markets.”
Warnings have gotten louder over time. In 2016, Sean Becketti, chief economist at mortgage company Freddie Mac, argued that climate change could trigger financial chaos by destroying coastal property and forcing millions of people from their homes. “The economic losses and social disruption may happen gradually, but they are likely to be greater in total than those experienced in the housing crisis and Great Recession,” he wrote.
The parallels with 2008 don’t end there. Over the past decade there has been a boom in the growth of “catastrophe bonds,” insurance products transferring the risk of hurricanes and other disasters to buyers on Wall Street and beyond—a secondary market that is different from the traditional reinsurance market.
Managers who work in the industry have explicitly compared what they’re doing to the creation of mortgage-backed securities in the 2000s, a financial innovation that transferred mortgage risk to Wall Street and helped cause the 2008 crash when those mortgages turned out to be much riskier than people thought.
Industry analyst Jay Patel warned in 2016 that people who invest in catastrophe bonds may not “understand what exactly they are getting themselves into. This sounds eerily familiar to the way investors behaved towards another seemingly obscure bond market before the financial crisis.” Catastrophe bond site Artemis replied that this is “a lazy way to avoid delving into the idiosyncrasies of what is a sophisticated asset class.”
Nobody outside the readers of a few arcane industry journals seemed to notice that exchange, however. “There are not many journalists paying any attention to the insurance industry,” Ross Hammond, who works on the activist campaign Insure Our Future, told VICE. “But when insurance insiders are making comparisons to the subprime mortgage crash it’s probably worth looking into.”
It blows Hammond’s mind that industry leaders—and our entire society for that matter—continue to treat climate change as an easily predictable threat. “In the case of a Category 5 hurricane hitting Miami,” he said. “That ain’t going to be gradual.”
Geoff Dembicki is the author of Are We Screwed? How a New Generation Is Fighting to Survive Climate Change. Follow him on Twitter.
This article originally appeared on VICE US.