Workers’ Comp Market Addresses Catastrophe Risks Following Sept. 11

April 15, 2002

Since the events of Sept. 11, companies underwriting workers’ compensation insurance are taking another look at the risks posed by catastrophes, both natural and man-made. Increases in reinsurance pricing and rating agency scrutiny are encouraging this re-examination. While the World Trade Center disaster increased industry perception of risk from man-made catastrophes, major earthquakes could also generate catastrophic levels of casualty claims.

A recent report by Risk Management Solutions, a provider of catastrophe models to the insurance industry, indicates that workers’ comp losses from a major earthquake could exceed those experienced in the World Trade Center disaster. The report was prepared using the company’s newly updated Workers Comp Earthquake catastrophe model.

According to the RMS report, a repeat of the 1906 Great San Francisco Earthquake (M 8.3) could cause as many as 78,000 injuries, 5,000 deaths, and over $7 billion in workers comp losses if it occurred again today. This compares to workers comp losses of up to $5 billion in the World Trade Center tragedy, according to recent estimates. The report also highlights the types of data that are valuable to differentiate risk. For example, building construction characteristics and local geological factors at specific locations can greatly influence the likelihood of building collapse and casualties in an earthquake.

Workers’ comp premium accounts for about 10 percent of total property and casualty business in the United States, but it is a line of business that was long thought to be isolated from major natural and man-made catastrophe risk. Insurers, reinsurers, and rating agencies are now recognizing the risks to this line of business, as well as the potential correlation of losses with property lines.

“The World Trade Center event served as a wake-up call that insurers need to be evaluating their exposure from major catastrophic events on a multi-line basis,” said Matthew Mosher, Vice President of A.M. Best. “To better evaluate potential exposure and provide a constructive influence to the industry’s implementation of a strategy for managing their potential loss exposure from major events, A.M. Best Company is developing a stress test which will estimate a company’s loss exposure to multi-line risks as part of our capital adequacy analysis.”

Insurers and reinsurers are responding by gathering more detailed information on workers comp exposures, and linking these databases to exposure information for other lines of business. For workers’ comp accounts, RMS recommends that companies obtain specifics on the location address, number of employees covered at the location, and construction characteristics. Multi-line writers can analyze this data along with property exposures using a catastrophe model to quantify the full impact of potential earthquakes. The underlying data also gives companies a better picture of total exposure aggregates to put an upper bound on losses from other unforeseen events such as terrorist attacks.

Peter Ulrich, managing director of enterprise risk at RMS echoed the increased awareness of catastrophe risk for workers’ comp writers.

“We have been analyzing casualty losses and workers’ comp risk since 1994, but the level of scrutiny today is the highest we have seen due largely to increases in reinsurance costs following last September’s losses. The Northridge Earthquake in 1994 didn’t generate the same level of attention because there were so few workers comp claims. But Northridge was far from a worst-case scenario. It occurred early in the morning before working hours, and the magnitude of the earthquake was large, but not as large as many other realistic scenarios for both Northern and Southern California. Following the World Trade Center tragedy, companies are more sensitized to the fact that worst-case scenarios can and do happen.”

The RMS study of earthquake risk is based on the company’s newly updated Workers’ Comp Earthquake model and its proprietary database of U.S. insurance industry workers’ comp exposure. The new model has been calibrated using casualty data from 135 earthquake events worldwide, and provides full probabilistic modeling of risks by street address, ZIP Code, county, or state, depending on the resolution of available exposure data.

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