The average resident of Tennessee, Kentucky, Missouri, or Arkansas probably does not spend a great deal of time worrying about the potential impact of an earthquake on the New Madrid Fault. After all, the largest quake in the past half century took place in 1968 and registered a relatively modest 5.4 on the Richter scale. While there are many quakes on the fault each year, the vast majority are too small to be felt. However, in the long run, the probability of a devastating quake on this fault is very high as P&C National Underwriter reported in an article published on June 30. According to a recent study, a 7.7 magnitude quake could result in $300 billion in direct economic losses and far higher indirect losses.
The probability a devastating quake on the New Madrid fault in any particular year is relatively low, but in the long run, it is very likely that devastating seismic activity will occur similar to the quakes that took place during 1811 and 1812. According to a recent USGS study (pdf), there is a 25 to 40 percent chance of a magnitude 6 or larger earthquake in the next 50 years:
It was the consensus of this broad group of scientists that (1) the evidence indicates that we can expect large earthquakes similar to the 1811–12 earthquakes to occur in the future with an average recurrence time of 500 years and that (2) magnitude 6 earthquakes, which can also cause serious damage, can be expected more frequently than the large 1811–12 shocks.
Based on this history of past earthquakes, the USGS estimates the chance of having an earthquake similar to one of the 1811–12 sequence in the next 50 years is about 7 to 10 percent, and the chance of having a magnitude 6 or larger earthquake in 50 years is 25 to 40 percent.
High Indirect Costs
The report goes on to describe the likely impact of a large earthquake along the New Madrid fault including the devastation that would take place along the Mississippi River and in locations such as Memphis where there are large numbers of buildings that are unlikely to withstand major seismic activity. Even more alarming are the indirect consequences of a quake as cited by the P&C National Underwriter article:
The center’s modeling concluded an earthquake of this size would leave 2.6 million households without power—that is, if the home remains standing. The report said 730,000 people would be immediately displaced and 215,000 would be seeking shelter. But three days after the catastrophe, 7.2 million would be displaced due to an extended lack of utility services. The upper Midwest, East Coast and other states just west of the seismic zone would be without adequate commodities for an extended period as the repair and restoration process fails to make progress.
Planning to Survive Worst Case Scenarios
The New Madrid fault represents only one example of a low probability but high impact event that could cause devastating consequences. Such risks pose important public policy questions regarding steps that should be taken to minimize the potential impact prior to a quake as well as plans for dealing with the consequences once a quake occurs. Insurance companies must make provisions for this type of risk whether or not they directly insure quake risks since business interruptions and indirectly insured damages will certainly occur.
Dealing with high impact events that have low probability during any given year is the cornerstone of intelligent insurance underwriting as well as intelligent investment. Even in cases where there is little that can be done to prevent a disaster, it is important to ensure that any known event, regardless of the probability, cannot destroy a business or an investment portfolio.
Disclosure: The author owns shares of insurance companies.