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Beyond the Worst-Case Scenario
I n August of 2017, Hurricane Harvey devastated the Southeast United States and caused record-breaking flooding in Houston, Texas. I’m from Houston and I still have rental properties in the area. Three of my rental houses were flooded out. When I went down to assess the damage, I had to take a boat in order to reach one of the houses. Longtime readers of my newsletter might remember when I wrote about this experience and the lessons I learned. We all knew Houston had substantial risk of flooding. We never imagined how bad it could be. In the risk management business, we identify exposure to loss, then we try to determine the maximum possible loss in dollar terms. Basically, we have to ask, “How bad could it be?” After Houston, I learned that we had greatly underestimated how bad things could be in terms of flooding. No one had predicted that Houston could get 50 inches of rain in a 72-hour period, but that’s what happened in 2017. Hurricane Harvey expanded our idea of exactly how bad things could be. A paradigm change is something we’re seeing again during the COVID-19 pandemic. This pandemic has exposed a new loss for businesses that we had never anticipated before. I’m not talking about the virus — I’m talking about the government closing down businesses due to the threat of the virus and then doing it for an indeterminate amount of time. There are situations in which you might expect the government to close your business down for a few days. For example, when a hurricane is approaching in order to evacuate, or after a natural disaster, while the water recedes or access roads are repaired. Nobody could foresee that the government would shut folks down for
weeks, potentially even many months, based on the anticipation of an event and with the end date determined by them, not the business owner. From my little corner of the world, in a span of less than three years, we’ve seen two worst-case scenarios that were far worse than I ever anticipated. No one in Houston ever thought they would get that much water in such a short period of time. Likewise, I don’t think anyone anticipated that the government would shut businesses down for so long. How does a business prepare for that? I don’t believe insurance coverage for government mandated shutdowns will be available anytime in the near future. Even if it is, it is unlikely anyone will be able to afford the premiums for this kind of insurance at this point in time. So if a situation cannot be adequately or efficiently addressed through insurance, then other methods will need to come into play. In my opinion with what I know today, future pandemic situations will demand a mitigation-type solution. I’m thinking businesses will have to proactively manage the financial risk through a combination of lines of credit, other banking arrangements, or through their own balance sheet. Additionally, businesses will want to be creatively prepared to keep operating should their physical establishments be shut down. Is it possible that businesses that were deemed ”essential” this time might not be so fortunate next time? And finally, given that the government has now done this to us once, will they be more likely or less likely to do it again? To do this right, we should challenge our assumptions about how bad things could really be. We better prepare for the worst, then maybe prepare a little more ... ?
“Frommy little corner of the world, in a span of less than three years, we’ve seen two worst-case scenarios that were far worse than I ever anticipated.”
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