Twenty years ago, a risk manager's sole responsibility was to buy insurance. Today, that list of responsibilities keeps growing. As such, it's easy to overlook some areas. One of the most commonly overlooked risk issues for many managers is earthquakes.

"Any discussion of earthquake risks is important, because this is usually a topic that ends up on the back burner," says Michael Egan, property officer with Swiss Reinsurance in Philadelphia. "Most of the attention these days seems to get paid to hurricanes, floods and terrorism."

Certainly, some risk managers have nothing to worry about. While all 50 states are theoretically vulnerable to earthquakes of various magnitudes, most areas tend to be relatively safe from extremely strong tremors. There are areas, though, where the risks are much greater. The U.S. Geological Survey has dedicated 30 years of research to better understanding seismic hazard areas across the nation. Structural engineers accepted the results of this research in the late 1990s.

"These are now in the International Building Code, 2000 and 2003 editions," says Chris Poland, CEO of Degenkolb Engineers, a San Francisco firm that specializes in engineering and earthquake projects. "The maps show that earthquake hazards are quite severe in at least 10 states."

These include such hotspots as California, Oregon and Washington, along with lesser-known risk areas including Missouri--site of the massive New Madrid earthquakes in the early 1800s--as well as Arkansas, Illinois, Kentucky, Tennessee, Mississippi and South Carolina.

A NEW LEVEL OF STANDARDS

One issue risk managers need to address is how much, if any, insurance coverage to purchase for earthquake risk. This isn't always easy, because the earthquake insurance market is unlike most other insurance markets.

"After a severe disaster, insurance companies tend to be reluctant to provide new coverage," says Howard Kunreuther, co-director of the Wharton Risk Management and Decision Processes Center at the University of Pennsylvania's Wharton School in Philadelphia. "Even if they do, deductibles and premiums both increase."

On the other hand, "We in the insurance industry tend to have short memories," says Swiss Re's Egan, who notes that the attention paid to earthquake risks diminishes as time passes after a major temblor. "Over time, as we are further removed from the event, the price of coverage seems to trend downward."

Another issue risk managers need to address is to what extent they want to become involved in retrofitting their facilities in order to reduce potential earthquake damage.

"As an underwriter, we obviously think that anything a company does to help minimize damage from an earthquake is money well spent," says Egan.

And as premiums climb, so does interest in taking preventive measures.

"We have found that when risk managers feel insurance premiums and deductibles are getting too expensive, they become more interested in spending money to 'harden' their buildings," adds Degenkolb's Poland. While working through the cost-benefit analysis of retrofitting was once a erapshoot in a lot of cases, the engineering profession is now able to bring a lot more relevant information to the table to help risk managers make intelligent decisions.

One of the most recent useful advances is called "performance-based engineering standards," a tool that allows engineers and others to look at how buildings will perform using a common vocabulary, rather than just saying that buildings meet the code or don't meet the code.

Performance-based engineering standards look at three areas:

* The first is life safety. This addresses the issue of making sure that people are not killed or severely injured in and around buildings as a result of an earthquake. Traditional building code information tended to focus almost exclusively on life safety issues.

* The second is damage control. This looks at what the resulting damage from an earthquake will cost and how long it will take to get the building repaired. "There are now software programs available that can predict how much losses will be," says Poland. "These programs can also estimate how much you can reduce the loss by making certain improvements to the building."

* The third area is business interruption. This looks at how long it will take before the infrastructure is repaired and the building can reopen, so the business can get back on its feet.

The standards are now being used not only in retrofitting, but also in new design.

"Performance-based design is an advancement over the old building codes, which was based on almost nothing other than life safety issues," says Nathan C. Gould, chief of technology and general manager for the EQE Structural Engineers Division of ABS Consulting, based in St. Louis. "In the past, an engineer would design for a single set of criteria."

After the 1994 Northridge earthquake heavily damaged the Los Angeles area, though, people began to realize that, in some cases, even minor structural damage could lead to significant economic losses.

"Performance-based design allows the design team of the architect, engineer, contractor, and owner to determine the appropriate level of ground motion and performance objectives for the building and the non-structural components in that building, in order to meet the owner's expectations," says Gould. For example, if you design a data center, the building itself may not be important, but the contents of the processes inside the building may be extremely valuable.

"As such, you would want performance to be at a higher level than normal," he says. "That is, you want more than just life safety performance. You want the building to be able to be back in operation very. quickly following an earthquake." In sum, Gould emphasizes the importance of paying attention to more than just the buildings and life safety issues. Pay attention to nonstructural items in terms of their implications for business interruption. He adds that the International Building Code is moving toward performance-based design code, but is not all the way there yet.

A BALANCING ACT

A good risk manager will look not only at insurance and engineering as separate issues, but he or she will also at the interaction between the two and create an ideal balance.

"Firms should adopt loss prevention measures that will reduce damage should an earthquake occur," says Kunreuther. Besides the obvious benefit of reducing damage, loss prevention strategies can lead to premium reductions. Some insurance companies, however, may have a difficult time determining how much of a reduction to actually give, since they may lack experience in this area, says Kunreuther. And the reduction could be a very small one.

"This may discourage companies from taking these measures," he says. Another issue that may dissuade companies from investing in loss prevention measures is the initial cost.

"Some companies may not want to incur large up-front costs for mitigation measures," says Kunreuther. "As a result, we are encouraging banks to offer earthquake mitigation measure loans that are tied to companies' mortgages." Then, if the mitigation measures end up being cost-effective, companies may come out ahead financially by reaping more in premium reduction savings than they pay in mitigation loan costs.

One risk manager who pays close attention to earthquake risks is Walter Boileau, vice president and treasurer of Sanmina-SCI, in San Jose, Calif.

"The earthquake market is still hard," he says. "As a result, a lot of companies are trying to figure out ways to retain risk in this area or spend their money retrofitting rather than spending it on premiums." This is what Sanmina-SCI has been doing recently. "When premiums are high, it makes more sense to invest money into facilities than it does to invest it in premiums," he says.

There is still a Catch-22, though. Up until a year or so ago, when buildings may not have been in use because of the slow economy, companies didn't want to invest in retrofitting, because they didn't know if they would be occupied again. Now that buildings are in demand again due to a stronger economy, companies may have extra cash for retrofitting. That can present a challenge, though.

"Retrofitting can be difficult when buildings are in use," says Boileau.

International Paper Co., of Memphis, is another company that is seriously weighing its earthquake risk management options and has conducted an analysis of earthquake risks.