The Disaster Issue – Where Insurers Fear to Tread

One storm is all it takes these days.

Anyone who’s been paying attention needn’t be reminded that even a post-tropical cyclone can cause major damage. That’s what Sandy was when she came on shore in New Jersey and devastated communities along the eastern seaboard. With winds reaching across an 1,100-mile geographic area, the storm caused damage as far away as Michigan, where storm warnings and high waves were posted for Lake Huron.

Just how much are these events costing insurers? The current estimated total of the devastation according to the U.S. National Oceanic and Atmospheric Association (NOAA): more than $50 billion. While that number is still climbing, it’s still less than half the total costs of Hurricane Katrina, which came in at $108 billion and was the costliest hurricane in U.S. history.

That’s just two storms. Other weather events have become quite costly, as well. For example, the expected total for the tornado damage caused in Moore, Okla., during the May 20, 2013, storms is set at $3 billion. One event, one big price tag. In fact, tornado insurance claims in Oklahoma just in the month of May have already topped $250 million in claims, says the state’s insurance commissioner. But what does one do about the weather?

Mitigation through insurance has been one of the go-to methods of risk transfer, but a number of back-to-back events that are increasing in severity and claims costs have insurers increasing premiums significantly to shore up reserves. Moreover, some insurers are backing off coverage altogether.

Flooded with Claims

From 2007 to 2011, flood claims averaged $35,000 per claim, according to FEMA. As the most common natural disaster, floods have occurred in every state. More intense storm systems have increased claims and were part of the reason the Biggert-Waters Flood Insurance Reform Act of 2012, which attempts to close a $27 billion deficit in the NFIP by adopting several changes, including removing subsidized rates for certain properties, boosts annual rate limits increases, defines severe repetitive loss properties (for single family residences as four or more claims, each for more than $5,000 and cumulatively more than $20,000), and increases annual deductibles.

The average homeowner can expect to see a 25 percent increase in rates over the next four years, which to Loretta Worters’ mind could cause a backlash effect.

“That’s going to make people buy even less flood coverage; so it’s a Catch-22. I don’t believe there is an availability problem but more of an affordability problem,” says Worters, vice president, Insurance Information Institute.

Flood insurance coverage rates are expected to increase an average of 25 percent as well over the next five years. However, in early June, the House of Representatives voted to approve an amendment to the flood insurance premium increases. Should the amendment become law, it would prevent FEMA from implementing the provision in the new NFIP law that affects premium increases.

Should the amendment fail to pass, homeowners can expect to see a dramatic increase to what FEMA has determined to be rates that reflect “actuarial risk.”

In one New Jersey town, a house that was demolished by Hurricane Sandy left the homeowner with a difficult choice – rebuild the home on 14-foot supports or pay a $30,000 annual flood insurance premium.

Twisters and Hurricanes

That such tough flood insurance decisions come after hurricanes is no surprise. That the claims are becoming prohibitively expensive for insurers is also no surprise, especially not to Dr. Peter Dailey, vice president and director of Atmospheric Science for AIR Worldwide. Dailey says that the population distribution makes it easy to understand the increase.

“It is AIR’s view that increases in natural catastrophe-related losses, including those for hurricanes, are primarily driven by the increase in and distribution of exposures in areas susceptible to natural perils,” he says. “As the number of properties in highly-exposed areas of the world and the overall penetration of insurance increase, insured losses from natural catastrophes will only continue to rise.”

It’s no wonder then that insurers, staring at what are becoming record-breaking claims, are finding ways to cushion the blow and spread the risk out so that their own reserves aren’t depleted in one event.

Worters says insurers in the coastal states from Florida to Maine limit their exposure by using a percentage deductible, replacing the named dollar amount deductible on most policies.

“If a house is insured for $300,000 and has a 5 percent deductible, the first $15,000 of a claim must be paid out of the policyholder’s pocket,” says Worters.

That’s a big change if you’re not paying attention.

At this writing, 19 states and the District of Columbia have hurricane deductibles: Alabama, Connecticut, Delaware, Florida, Georgia, Hawaii, Louisiana, Maine, Maryland, Massachusetts, Mississippi, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, South Carolina, Texas, Virginia and Washington, D.C. Agents in those states should be aware of the policy language and make sure customers understand the difference between the dollar amount and the percentage amount.

That is, if the insurer decides to renew. As Worters says, each insurer is different. For insurers with a large portfolio of business in one area, there could be a decision to reduce their risks by not renewing some of the policies.

“This is a prudent course of action on the part of an insurer, who may make the decision with a view to managing the risks of the other households they insure,” Worters says. Hurricane deductible plans must be reviewed by the state insurance department, she says.

Currently, there has been no action by insurers to limit exposure in tornado-prone areas, though that too could be happening on a case-by-case basis. Worters says depending on the state, insurers determine the level of windstorm or wind/hail deductible and where it should apply, except in Florida where state law dictates these variables.

How Dry I Am

Sometimes the problem isn’t water, but lack of it.

Last year, severe drought plagued nearly half the United States, killing crops and herds across the country. According to a National Climatic Data Center (NCDC) report, approximately 55 percent of the continental United States experienced moderate to extreme drought the last weeks of June 2012.

The cost to insurers: $15 billion, according to Munich Re.

For Charles Collier, vice president of the Albuquerque, N.M., branch of Poms & Associates, an insurance brokerage firm, it’s been a dry season for more than 10 years. His state, New Mexico, isn’t a state that normally gets a good deal of rain. However, Collier says as far back as he can remember, the state has been struggling with the lack of what little rain they do get.

It’s a struggle the state is losing. NOAA’s National Weather Forecast Office in Albuquerque reported as of June 4, most of the state was experiencing extreme to exceptional drought conditions. The rest of the state was suffering through moderate to severe conditions. The statewide precipitation was 47 percent of normal, with other areas posting just 30 and 31 percent of normal.

With all that dryness comes the larger threat – fire. As we spoke, Collier was handling claims that were the result of four fires in the state. A total of nearly 34,000 acres have burned, and with little rain expected through December, that total could rise significantly as more fires are sparked.

Collier says homeowners who don’t have coverage for fire aren’t going to be able to buy it as the fire starts appearing on the horizon.

“If there is a forest fire, the carriers usually put a moratorium on whatever ZIP codes are in the path of the fire,” he says. “Once the fire has been contained, they release the moratorium and continue writing business.”

Collier says he’s not seen insurers failing to renew coverage in most cases, but the premiums can often skyrocket, as can deductibles. Minimum deductibles, he says, typically average $2,500 for hail or fire in higher risk areas.

“Carriers are telling the brokers to expect those types of underwriting changes, and sometimes, higher than normal premium due to the high risk of fire,” he says.

In a few cases, Collier has seen coverage applications denied. One customer living in rural Colorado had suffered a serious fire. When the customer applied for coverage quotes, two insurers refused the business based on the previous loss and the remote location of the property. “It had taken the fire department two hours to reach the property,” Collier says.

Yet not all damage from drought is covered. Collier says his state’s largest cattle producer has reduced his herd by 75 percent. The reason: drought-related animal loss is excluded from coverage.

Excluding Terrorism

Then there’s TRIA. On Sept. 10, 2001, terrorism insurance was a free coverage on most policies.

In one day, it became an expensive, impossibly scarce product that had to be created from scratch to cover the now all-too-real risks that terrorism brings. Insurers came into the terrorism mitigation business cautiously, a caution that has proven to be prudent. Several years and a number of terrorist events later, it’s a risk that’s being rethought by insurers.

The Terrorism Risk Insurance Act is set to expire at the end of 2014. That’s when analysts predict insurers will shy away from insuring large metropolitan areas should the Act not renew. At the very least, premiums will increase significantly, say some experts.

That would depend on the demand, of course. A recent Marsh report revealed that 62 percent of U.S. companies purchase terrorism insurance, a rate that has been fairly steady since 2009. Regionally, the Northeast saw 77 percent buy-in from companies, which is more than the Western portion of the country (53 percent). Media companies buy the most terrorism coverage at 81 percent.

Yet should the government not continue as the program’s backstop, many companies could find themselves without coverage. As policies tend to be renewed in the fall, TRIA’s failing to renew in December could cause a huge gap for companies in metropolitan areas.

“Of course, individual insurers will make their own decisions based on their individual books of business,” says J. Stephen Zielezienski, senior vice president and general counsel for the American Insurance Association (AIA). But, generally, without the stability provided by the shared loss program established under TRIA, insurers will need to carefully determine how they would manage their exposure to terrorism losses, particularly for insurance lines like workers’ compensation that do not allow insurers to limit their exposure and for terrorist attacks that involve unconventional weapons like nuclear devices.”

Zielezienski adds that some insurers could decide to reallocate capacity or somehow reduce their exposure through what he calls “difficult choices on which risks they write.”

He says because the frequency of terrorism can’t be modeled and because potential attacks are known only to the government, modeling companies and insurers can’t get an accurate portrait of the risk.

Will Congress fail to renew? It’s possible, but the decision wouldn’t be based on claims data. To date, TRIA has not paid out on any claim. However, the increase in terrorist activity could have legislators nervous about potential payouts.

Predicting the Hard-to-Predict

It’s a valid trepidation. If hurricanes are any indication, losses can mount quickly and exponentially. In the case of hurricanes, populations migrate to coastal areas. Dailey sees the increased coastal population having a huge impact on an insurer’s ability to cover losses adequately.

“According to AIR, in the past five years, the insured value of properties in coastal areas of the United States increased at a compound annual growth rate of just under 4 percent,” says Dailey. “Indications are that, as the economy recovers, the rate of growth will pick up. At a historical rate of 7 percent, the total values insured would double every decade.”

Add to that a 38 percent total exposure located in the Gulf and East Coast states, which accounts for 16 percent of the total value of properties for the entire country, and it’s no surprise that insurers are working hard to transfer part of that loss back to the homeowner.

Some weather detection methods are helping insurers unravel the business of mitigation, prediction, and prevention. In the case of tornadoes, hurricanes, and severe storms, NOAA, along with several private vendors, have developed methods of detection that allow for preparedness that can save lives.

In the case of the Moore tornado, residents had a 36-minute window in which to take shelter, according to the National Weather Service. The first warning went out 16 minutes before the tornado touched down. Average warning time is 14 minutes.

What has yet to be predicted is terrorism. Experts agree it’s difficult to predict with any certainty human behavior. A 2010 President’s Working Group on Financial Markets report states “Market participants (policyholders, insurers, and reinsurers) remain uncertain about the ability of models to predict the frequency and severity of terrorist attacks.”

With other loss events, catastrophe modeling allows companies to understand their risks and shore up not only their properties, but their finances ahead of a catastrophic event. “Today, models are more sophisticated as more data as computing power has increased almost exponentially, allowing for more precise and higher resolution model output,” says Dailey.

“The industry, too, has made enormous strides in collecting detailed exposure data that is essential to produce more reliable model results – although more progress is still needed.”

Topics Florida Catastrophe Carriers USA Profit Loss Claims Flood New Jersey Hurricane Homeowners