Ken Silverstein EnergyBiz Insider Editor-in-Chief

When Hurricane Andrew ripped through Florida and the Gulf Coast in August 1992, it was the most expensive natural disaster in America at that time, costing insurers $15 billion and $11 billion in uninsured damages or those covered by the federal government. The price tag associated with Hurricane Katrina is expected to cost insurers as much as $50 billion with uninsured losses and government expenditures adding another $100 billion. No one expected that type of devastation, but they did expect hurricanes.

The paradox is there is a low probability a catastrophic occurrence, but a high exposure if it does happen. So local officials are faced with the dilemma of spending the millions necessary to beef up building codes and buy insurance to prepare for something that may never happen or foregoing such expenses and hoping that the federal government will find the money to repair whatever damage does occur.

"It's a priority-setting process," says Tom Vance, risk manager for the city of Anaheim, Calif. "It is easy to second guess what should have been done after a disaster." Anaheim, for instance, has chosen to build state-of-the-art public facilities, as well as insure itself against earthquakes. Have the millions in insurance premiums been worth it? Well, the area has endured some wretched earthquakes and many of the public entities there including electric, water and gas plants have endured the wrath.

Precautions, of course, are no guarantee that disaster will not wreak havoc. But, is there more that cities and towns can do to avoid costly damages? It's a matter, though, of deciding what is cost effective. After Andrew hit Florida, the insurance department there said as much as 40 percent of the destruction could have been prevented if building codes had been up to standard. And, in the aftermath of the Northridge earthquake, buildings that were not up to snuff have either been demolished or retrofitted while the state has spent billions reinforcing freeways and overpasses.

New Orleans, for example, had always been considered a hot spot for potential hurricane-related disasters. Its levees were built to withstand "category three" winds -- not the "category four or five" winds that hit the city in late August. But there is still much that could have been done and should have been done to lessen the troubles, says Vance. The levees and pumps - some of which were non-functioning -- should be routinely inspected and the disaster preparedness plans could have been well-rehearsed.

Dust Not Settled

Computer simulations are essential to understand the level of exposure to property and facilities. And if such simulations and subsequent calculations indicate that billions are needed to withstand the worst-case scenarios, it becomes a matter for local, state and federal officials to decide, adds Vance. The risks must be understood by all.

"A risk manager has to think about the sky falling," adds Dan Pliszka, an insurance broker for Marsh in Charlotte, N.C. "But, they have to be careful about crying wolf." Practically speaking, the focus must be on the most critical facilities and the potential losses that could occur if those entities were wiped out. The next step is to engineer the agreed upon solutions. In the case of an area that lies in a flood plain, utilities would build walls around substations, or elevate them.

Then there is the question of how to pay for the actual damages. Utilities and other businesses try and insure for catastrophic events and retain smaller risks, oftentimes as high as $1 million. Other times, they might pool their risks or create self-insured storm reserve funds. In the case of major storms, the costs add up. In some cases, power companies are expected to pay for the costs and then charge them against current year earnings. In others, they can add a surcharge to customer bills and recover their expenses.

While several utilities have storm reserve funds to pay for disasters, the process is not uniform and the size of those funds may be inadequate. In such cases, utilities have to petition their public service commissions for rate increases to pay the additional costs.

Consider Florida, which was particularly hard hit last year as four hurricanes blew through the state. The storms required investor-owned utilities to replace more than 3,000 miles of wire as well as 32,000 poles and 22,000 transformers.

In Florida, utilities are allowed to recoup all of their storm losses incurred in 2004 with bonds. The state issues 10-to 20-year bonds that are paid off by charging customers about $2 a month.

At the same time, the Florida Public Service Commission authorized a Storm Reserve Fund in 1992 after Hurricane Andrew. Investor-owned utilities ante up and then accrue a set amount each year based on the probability that they would get hit by a major hurricane. The fund covers only operation and maintenance costs and can be used for significant storms. Progress Energy, for instance, pays $6 million a year into the fund and had about $41 million in reserve after the series of hurricanes hit the area last summer, although that has since been drawn down further.

"FPL feels comfortable that we can recover prudently incurred storm restoration costs through either the storm cost recovery legislation... or through a separate surcharge...," says Mayco Villafana, manager of corporate communications for FPL.

Municipal utilities, on the other hand, rely on the Federal Emergency Management Association (FEMA) for financial support in major disasters. FEMA typically pays 75 percent of the costs that qualify for federal assistance, with the state or local municipality picking up the rest of the tab.

The dust has yet to settle on the damages caused by Hurricane Katrina. Commercial and insured losses will undoubtedly pile up but the focus remains on response and recovery -- and the price tag will run well into the billions. Toward that end, public and private insurance will play key roles. Utility customers, too, will chip in.

In its darkest hour, it may be difficult for the Gulf Coast region to find a ray of light. The good news is that Florida survived Hurricane Andrew and California lived through the Northridge earthquake, and the surrounding communities are doing well today. Katrina's devastation is far more widespread but the political will to fix both the immediate and long term problems has gestated.

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