| HOT TOPICS & ISSUES UPDATES |
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Catastrophes: Insurance
Issues
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THE
TOPIC
APRIL
2005
The term “catastrophe” in the
property insurance industry denotes a natural or
man-made disaster that is unusually severe and
that affects many insurers and policyholders. An
event is designated a catastrophe when claims
are expected to reach a certain dollar
threshold, currently set at $25
million.
Before the 2004 hurricane
season, the 9/11 terrorist attacks ranked as the
most costly U.S. catastrophe in terms of
property damage alone at $18.8 billion — more
when liability claims are included. The insured
losses caused by the four hurricanes that struck
Florida and other East and Gulf coast states in
2004 is estimated at $20.5 billion, exceeding
9/11 property damage. The 2004 hurricane season
resulted in more than two million claims, far
more than the 750,000 claims filed after
Hurricane Andrew in 1992 which is the industry’s
single most costly natural disaster to date.
The 9/11 terrorist attacks cost insurers
about $31.7 billion in total, including
liability and life insurance claims. The attacks
which affected more kinds of insurance and more
commercial policyholders than any other
disaster, led Congress to pass the Terrorism
Risk Insurance Act (TRIA) in November 2002.
TRIA, which expires at the end of 2005, provides
a federal backstop for future terrorist acts,
making it easier for insurers to calculate their
maximum losses for such a catastrophe and thus
to price the coverage. Congress is considering
legislation to renew the Act.
Until the
2004 hurricane season, the enormity of the
attack overshadowed what is still the greatest
threat to insurers and their policyholders:
natural disasters.
The typical homeowners
insurance policy covers damage from a fire,
windstorms, hail, riots and explosions — as well
as other types of loss such as theft and the
cost of living elsewhere while the structure is
being repaired or rebuilt after being damaged.
Commercial property insurance policies generally
cover the same causes of loss with some
variation, depending on the coverages selected.
Flood and earthquake damage are excluded under
homeowners policies – separate policies are
available--but are covered under the
comprehensive portion of the standard auto
policy.
Over the 20-year period, 1984 to
2003, tornado losses made up 33.7 percent of
total catastrophe losses, followed by hurricanes
(27.1 percent), terrorism (11.0 percent), winter
storms (10.6 percent), earthquakes (9.4
percent), wind/hail/flood (4.0 percent), and
fire (3.3 percent). Civil disorders, water
damage and utility services disruption combined
represented less than 1
percent.
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RECENT
DEVELOPMENTS
- Catastrophe Losses: Thousands of
homeowners and flood insurance claims have been
filed in Southern California following record
rains. Insurance adjusters with a background in
catastrophe claims are assessing the damage to
determine whether or not the damage is covered.
Damage from mudslides and landslides is not
covered by standard homeowners insurance
policies but flood insurance covers
mudflows.
- Insured losses from the tsunami that was
triggered by a magnitude 9.0 earthquake under
the Indian Ocean are likely to be modest
compared with the enormity of the human and
economic losses. Huge walls of water destroyed
coastal communities in at least half a dozen
countries across South-East Asia. An earthquake
in Indonesia at the end of March severely
damaged property on several islands and many
people were killed. However, a large portion of
property losses in both disasters may be
uninsured because the non-life insurance
industry in most South-East Asia countries is
not well developed.
- In the United States, insured catastrophe
losses for 2004 are estimated at a record $27.3
billion, exceeding 2001 losses, according to
ISO’s Property Claim Services unit (PCS). (See
charts below.) Policyholders in 42 states and
Puerto Rico filed nearly 3.35 million claims.
Catastrophe losses for 2001, which included
losses from the September 11 terrorist attack,
now stand at $26.5 billion.
- In December 2004, a federal grand jury found
that the destruction of the World Trade Center
complex was the result of two separate attacks
and therefore two claims rather than one. If
this finding is allowed to stand on appeal, the
$18.8 billion in property damage losses would
increase to $19.9 billion. The ruling would only
apply to 9 of the insurers providing coverage.
Liability, aviation, workers compensation, life
and health insurance losses were not included in
this total. The insured loss figure for 9/11
property damage was revised by ISO in March 2004
from $20.3 billion.
- In the third quarter 2004, there were eight
catastrophes that affected 21 states and Puerto
Rico, including the four major hurricanes,
Charley, Frances, Ivan and Jeanne. Losses
estimates for the third quarter have been
revised. According to PCS, Florida suffered
$18.8 billion in insured losses, on 1.63 million
claims, more than twice as many as were filed
following Hurricane Andrew. Alabama suffered
$1.8 million in losses. More than one in five
Florida homes was damaged by a hurricane in
2004; an estimated 37,000 homes were destroyed
according to the Governor’s office. Colorado,
Pennsylvania and Georgia each suffered
significant damage. In Florida, claim payments
so far suggest that Hurricane Charley was the
most destructive storm of the four major
hurricanes with more than $8 billion in losses
projected.
- Hurricane Jeanne which made landfall on the
east coast caused substantial damage to mobile
homes. Mobile home claims represented 19.6
percent of claims filed after Hurricane Jeanne
compared with about 10 percent for each of the
three other storms, according to the Florida
Office of Insurance Regulation. Hurricane
Charley caused the highest percentage of auto
claims.
- Six major hurricanes (category 3 or above)
hit the eastern coast of the United States
during the 2004 hurricane season, the four noted
above along with Alex and Gaston. There were 15
tropical storms, nine of which became
hurricanes. About 120 people lost their lives as
a result of the four major hurricanes: Frances
(37), Charley (34), Ivan (30) and Jeanne (18).
- Only one small insurance company, American
Superior Insurance Company, which had a large
concentration of policyholders in the Florida
Panhandle, has been declared bankrupt as a
result of the huge number of hurricane-related
claims. Some legislators in disaster-vulnerable
states would like to see the federal government
create a national catastrophe fund. California
Insurance Commissioner John Garamendi has
suggested a national disaster insurance program
to spread the risk of disasters more widely.
- Forecasts for the 2005 Atlantic Hurricane
Season: Forecasters at Colorado State
University predict above average hurricane
activity for 2005. In an April 2005 forecast for
the Atlantic Basin, they estimate 13 named
storms for 2005, of which seven will be
hurricanes and three intense hurricanes,
category 3 or higher. The April forecast
predicts a more severe hurricane season than the
one issued in December 2004. The probability of
a major hurricane making landfall somewhere
along the U.S. coastline is 73 percent compared
with an average of 52 percent over the last 50
years. Other forecasters predict a similarly
active hurricane season.
- Florida Legislation: Committees in
both Houses of the legislature are considering
various proposals that could change the
environment for property insurance in the state.
Among the proposals being considered are more
catastrophe deductible options with a
commensurate increase or decrease in premiums.
Currently, consumers can choose either a 2 or 5
percent deductible -- most choose 2 percent --
but under the proposed legislation the option to
choose a lower deductible, 1 percent, or a
higher one, 10 percent, would be added. The 1
percent deductible would raise insurers’
exposure to loss, increasing the likelihood that
some would cut back on how much homeowners
insurance they write in the state.
- Also on the table are proposals that would
lower insurers’ deductibles or retentions for
the Florida Hurricane Catastrophe Fund, see
below, so that insurers get reimbursed by the
Fund for windstorm losses at a lower level of
losses; require insurers to create standard
rating territories or geographical areas that
have the same rates to make it easier for
consumers to compare prices for coverage; and
changes in the way Citizens Property Insurance
Corporation operates and sets rates. In counties
that lacked a reasonable degree of competition
in the marketplace, as determined by the
insurance department, Citizens would charge an
actuarially sound rate rather than a rate higher
than the top 20 insurers.
- The Joint Committee on Hurricane Insurance
issued its recommendations in February. The
committee was appointed in January to study the
state’s property insurance market and the
availability and affordability of coverage,
focusing specifically on hurricane deductibles,
the level of losses insurers have to pay before
the reinsurance available from the Florida
Hurricane Catastrophe Fund (FHCF) is triggered
(retentions), and the various problems related
to the Citizens Property Insurance Corporation
(CPIC), the state’s property insurance pool.
Many of the current proposals being discussed in
the Florida legislature follow the Committee’s
recommendations.
- Meeting in special session, lawmakers passed
a bill in December 2004 that eliminates multiple
hurricane deductibles and reimburses homeowners
who paid more than one deductible this hurricane
season. Beginning in 2005, homeowners will be
subject to a single hurricane deductible per
year. The more than 29,000 homeowners who paid
more than one deductible will be eligible for
reimbursements of up to $10,000 for two
deductibles and up to $20,000 for three or four
deductibles. The $150 million to pay for this
will come from the Florida Hurricane Catastrophe
Fund which insurers have been paying into since
1993 for reinsurance coverage. To offset these
costs, all Florida policyholders will see a .5
percent increase in homeowners premiums for the
next five years to repay the catastrophe
reinsurance fund for the money borrowed and a
rate increase of between 1 and 3 percent to
compensate insurers for additional losses they
will have to pay in some hurricane seasons
because of the elimination of multiple
deductibles.
- Florida Governor Jeb Bush and legislative
leaders have extended until March 31 2005 the
order prohibiting cancellations and nonrenewals
of homeowners policies where work on
hurricane-related damage has not been completed.
Homeowners with unrepaired damage would have
difficulty obtaining a new policy from another
company. The new insurer would want the old
insurer to sign off on the repairs before taking
on the responsibility of insuring the
property.
- Residual markets: In Florida, where
many insurers in the private market have reached
the maximum in terms of their ability to insure
more homeowners in high risk areas, some
insurers are refusing to accept new applicants.
Those who cannot get coverage in the private
market are forced to get coverage from the
Citizens Property Insurance Corporation.
Citizens has been trying to shed policies by
paying private insurers to take them on, see
also Background section. As of the end of
February 2005, the insurer of last resort had a
$525 million deficit, having paid out $1.6
billion in claims. Policyholders in the state
may be assessed a one-time payment to make up
for the shortfall. For a home with a homeowners
premium of $1,500, the assessment would be about
$100. Another solution being discussed is use of
sales tax revenue to offset the Citizens
deficit. Sales tax collections were boosted by
hurricane-damage generated business such as the
sale of building construction materials.
- As of the end of February, Citizens had
written more than 455,000 high risk (coastal,
wind-only) policies and an additional 345,000
residential property policies, policies that
include windstorm coverage. Its total exposure
to loss, including apartment and condominium
buildings, was more than $134 billion. Over the
past six months, the number of high risk
policies in the pool has increased and the
number of residential policies has
decreased.
- In Louisiana, when the Citizens high risk
pool was formed in 2003, lawmakers approved a
provision that allows for bond financing. This
spreads the cost of paying for claims over a
longer period, which in turn allows insurers to
pay losses over a longer period. In both states,
insurers can pass on the cost to policyholders
in the form of a surcharge. In Alabama, the pool
has approved a $20 million assessment due to
Hurricane Ivan claims.
- Reducing Catastrophe Losses: The
Institute for Business & Home Safety (IBHS)
has found that steps aimed at improving building
design and safety paid off during this hurricane
season. For example, structures that had
properly installed roof straps that attach
rafters or roof trusses to outside walls
typically sustained less damage than those
without them. Impact-resistant doors, windows
and shutters also provided protection. However,
IBHS says, soffits on many building were blown
out of the eaves, wind-driven rain caused water
damage around windows and doors, and roof tiles
set with mortar became missiles. The IBHS has
also been working to improve the safety of
manufactured homes and their ability to resist
damage caused by high winds.
- Preliminary results from a study of Florida
homes built between 1994 and 2002 and those
built after 2002 shows that those built after
2002 suffered about 40 percent less damage. In
August 2004, the Florida Building Commission
decided to strengthen the wind resistance
standards in broad areas of the state such as
the Panhandle that could be hit by 100 mph winds
but which had previously not been subject to
stricter codes. In 2002, building contractors
said higher wind resistance codes would add
unnecessary costs to homes in the west of the
state.
- Hurricane Catastrophe Fund: In
Florida lawmakers expanded the bonding capacity
of the state’s Hurricane Catastrophe Fund to $15
billion from $11 billion. The Fund can generate
revenue through the issuance of bonds. The
maximum amount that can be issued is the
difference between the funds on hand and $15
billion. The cost of bonds are paid for by
emergency assessments on insurers. Lawmakers
also increased from 6 to 10 percent the annual
surcharge that insurers can tack onto insurance
policies to help finance bond issues. Under the
new legislation, surplus lines companies, which
are not part of the regular market, must also
pay the assessments. The fund, which is run by
the state to provide low cost reinsurance, was
set up in 1993 to encourage insurers to stay in
the Florida marketplace after reinsurance became
more difficult and expensive to obtain following
Hurricane Andrew.
- A bill, H.R.846, that would create a federal
catastrophe reinsurance program has been
introduced in the House of Representatives.
Under the legislation which has been introduced
several times before, the Treasury would auction
excess-of-loss reinsurance contracts, a type of
reinsurance that provides coverage above a
certain level of losses. Protection purchased
from the federal government would be cheaper
than from the private market, thus reducing the
cost of homeowners insurance. Some insurers are
also promoting the concept of catastrophe
reserves which would allow insurers to establish
long-term reserves for catastrophes that were
exempt from federal taxes.
- Chief Financial Officer Tom Gallagher
expects $3 billion will be paid out of the
Hurricane Catastrophe Fund, about half of its
cash on hand. As with hurricane deductibles for
policyholders, there is a separate deductible
for each hurricane. The industry’s deductible or
retention is now set at $4.5 billion, meaning
that insurers that purchase reinsurance from the
Fund must pay claims that in total add up to
$4.5 billion before a single insurer can be
reimbursed by the Fund. If the hurricanes had
been a single storm, the Fund would have paid
out $10.5 billion. The industry’s retention for
2005 is likely to grow to $4.96 billion under
the current law.
- The Terrorism Risk Insurance Act
(TRIA): In Congress, a bipartisan group of
senators has introduced S467, The Terrorism Risk
Insurance Extension Act of 2005, which extends
legislation first passed in November 2002 for
another two years until a permanent solution to
funding terrorism losses is agreed upon. The
bill, which is similar to a bill introduced last
year, would extend TRIA to the end of 2007 but
expand the current measure to include group life
insurance. TRIA provides federal funds to help
pay for catastrophic losses due to a terrorist
attack. Federal government payments are
triggered after insurers’ losses (industrywide
retentions or deductibles) have reached a
certain dollar amount, based on maximums for
each commercial lines insurance company and a
maximum for the industry as a whole. The
program, which does not cover auto and
homeowners insurers or reinsurers, is designed
to handle up to $100 billion per year in claims,
including insurance company payments.
Industrywide retentions would increase from $15
billion to $17.5 billion in 2006 and $20 billion
in 2007.
- Under this year’s legislation, TRIA coverage
would be extended to cover losses that occurred
in 2008 when multi-year policies issued in 2005
were still in effect in 2008. The legislation
requires a report to be submitted to Congress on
the long-term availability and affordability of
insurance for terrorism risk and continues the
“make available” provision, see following
paragraph.
- At hearings before the Senate Banking
Committee in April, New York Acting
Superintendent of Insurance Howard Mills.
speaking on behalf of the National Association
of Insurance Commissioners Terrorism Insurance
Group, made three points: the insurance
marketplace is not yet ready to take on the risk
of providing coverage for acts of terrorism on
its own; Congress should extend TRIA at least
until 2007; and there is no evidence to support
the Congressional Budget Office’s charge that
TRIA lowers the incentives for property owners
to improve safety. He said that TRIA has been a
success and has operated exactly as Congress
intended. Others giving testimony outlined
proposals to enhance the market for terrorism
insurance including allowing insurers to form
tax-exempt entities or reserves for catastrophic
losses. Most senators at the hearing voiced
their support for TRIA but some said that they
would prefer a free market solution but were
willing to consider any workable plan.
- Some observers believe that action on the
bill will be delayed until after the Treasury
has issued its mandated report on the
effectiveness of the TRIA program. The report is
due by June 2005. In the meantime, the General
Accounting Office (GAO) has issued a report
outlining the various approaches taken to
address natural and man-made catastrophic
disasters within the United States, and abroad
where governments play a larger role in assuming
terrorist risk. It concludes that although steps
have been taken to strengthen the insurance
industry’s capacity to assume catastrophic risk
and deal with losses of $50 billion or more, it
has not been tested by a truly catastrophic
event or series of events. Losses of this
magnitude could cause significant economic and
market problems, the GAO says.
- The U.S. Treasury Department announced in
June 2004 that it was extending through 2005 a
provision in TRIA that requires insurers that
sell commercial insurance to make terrorism
coverage available. Insurers had been pressing
for a decision from the Treasury to reduce the
uncertainty surrounding coverage in policies to
be sold in 2005 and for Congress to extend TRIA
beyond 2005 when the law is due to
sunset.
- Flood Insurance: The National Flood
Insurance Program has been extended until
September 2008. It requires property owners who
file repeated flood claims to be offered
opportunities to sell their homes to the
government or to mitigate flood damage either by
elevating or moving their homes. Those refusing
help would be denied disaster aid in subsequent
floods and would eventually be subject to the
full actuarial rates for flood coverage for
their properties. The bill makes information on
flood insurance more widely available and
institutes minimum training and education
requirements for agents who sell flood
insurance. Complaints stemming from Hurricane
Isabel in 2003 showed that some people did not
understand the coverage.
- The number of flood policies in force is
growing but so are the claims. In 2003, there
were 4.6 million policies in force compared with
4.5 million the previous year. Premiums grew
from $1.8 billion in 2002 to $1.9 billion in
2003. Estimated claims data for 2004 are already
available. The number of claims jumped from
32,189 in 2003 to 37,659 in 2004 and the cost of
flood losses paid rose from $605.4 million in
2003 to $1.2 billion in
2004.
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THE
TEN MOST COSTLY CATASTROPHES, UNITED
STATES
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Insured loss ($
millions) |
Rank |
Date |
Peril |
Dollars
when occurred |
In
2004 dollars (1) |
| 1 |
Aug. 1992 |
Hurricane
Andrew |
$15,500 |
$20,869 |
| 2 |
Sep. 2001 |
World Trade
Center, Pentagon terrorist attacks (2) |
18,800 |
20,053 |
| 3 |
Jan. 1994 |
Northridge, CA
earthquake |
12,500 |
15,933 |
| 4 |
Aug. 2004 |
Hurricane
Charley |
7,475 |
7,475
|
| 5 |
Sep. 2004 |
Hurricane
Ivan |
7,110 |
7,110
|
| 6 |
Sep. 1989 |
Hurricane Hugo |
4,195 |
6,391 |
| 7 |
Sep. 2004 |
Hurricane
Frances |
4,595 |
4,595
|
| 8 |
Sep. 2004 |
Hurricane
Jeanne |
3,440 |
3,440
|
| 9 |
Sep. 1998 |
Hurricane
Georges |
2,900 |
3,361 |
| 10 |
Jun. 2001 |
Tropical Storm
Allison |
2,500 |
3,099 |
|
(1) Adjusted
to 2004 dollars by the Insurance Information
Institute.
(2) Property
coverage only.
Source:
ISO; Insurance Information
Institute. | |
|
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INSURED LOSSES FOR U.S.
CATASTROPHES, 1995-2004
(1)
($
millions)
Year |
Number
of
catastrophes |
Number
of
claims (millions) |
Dollars
when
occurred |
In 2004
dollars
(2) |
| 1995 |
34 |
2.7 |
$8,310 |
$10,300 |
| 1996 |
41 |
3.9 |
7,375 |
8,879 |
| 1997 (3) |
25 |
1.6 |
2,600 |
3,060 |
| 1998 |
37 |
3.5 |
10,070 |
11,670 |
| 1999 |
27 |
3.3 |
8,321 |
9,435 |
| 2000 |
24 |
1.4 |
4,600 |
5,046 |
| 2001 |
20 |
1.6 |
26,548 |
28,317 |
| 2002 |
25 |
1.8 |
5,850 |
6,143 |
| 2003 |
21 |
2.6 |
12,885 |
13,228 |
| 2004 |
22 |
3.4 |
27,275 |
27,275 |
|
(1)
Includes catastrophes causing insured losses to
the industry of at least $5 million from 1995
to1996. Data for 1997 to 2004 include
catastrophes causing at least $25 million in
losses.
(2) Adjusted to 2004 dollars by the
Insurance Information Institute.
(3) 1997 was
the first year that ISO increased its dollar
threshold for defining catastrophes from $5
million to $25 million (see footnote 1). The
number of catastrophes fell from 41 in 1996 to
25 in 1997, mostly due to this
reclassification.
Source: ISO;
Insurance Information Institute.
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MAJOR
U.S. CATASTROPHES,
2004
As of
February 2005
Date
|
States
|
Perils
|
|
Estimated
Loss Payments (Millions of Dollars)
|
| |
|
|
|
|
| Jan. 9-12 |
CT, DE, MA, ME,
NH, NJ, NY, PA, VT, RI |
Winterstorm |
|
$413 |
| |
|
|
|
|
| |
|
|
|
|
| |
|
|
FIRST
QUARTER |
$1,035
(1) |
| |
|
|
|
|
| |
|
|
SECOND
QUARTER |
$2,330
(2) |
| |
|
|
|
|
| |
|
|
FIRST
HALF |
$3,365 |
| |
|
|
|
|
| |
|
|
|
|
| Aug. 13-15 |
FL, NC, SC |
Hurricane
Charley |
|
$7,475 |
| |
|
|
|
|
| Sep. 5 |
FL, GA, SC, NC,
NY |
Hurricane
Frances |
|
$4,595 |
| |
|
|
|
|
| Sep. 16-21 |
AL, FL, GA, NC,
NY, OH, PA, 8 other states |
Hurricane
Ivan |
|
$7,110 |
| |
|
|
|
|
| Sep. 15-29 |
FL, GA, NY, PA,
SC, PR, 4 other states |
Hurricane
Jeanne |
|
$3,440 |
| |
|
|
|
|
| |
|
|
|
|
|
|
|
THIRD
QUARTER |
$23,460
(3) |
| |
|
|
|
|
| |
|
|
FOURTH
QUARTER |
$450
(4) |
| |
|
|
|
|
| |
|
|
FULL
YEAR |
$27,275 |
|
(1)
Includes five events. (2) Includes six events.
(3) Includes eight events. (4) Includes three
events.
Note:
Catastrophes are assigned serial numbers by the
Property Claim Services (PCS) division of
ISO when the insured loss to the industry
resulting from an occurrence reaches at least
$25 million. This
chart identifies only the most severe
catastrophes; quarterly totals include
additional catastrophes.
Source:
ISO. | |
|
|
TOP
2004 HURRICANES
Hurricane |
Insured
losses ($ billions) |
| Charley |
$7.48 |
| Frances |
4.60 |
| Ivan |
7.11 |
| Jeanne |
3.44 |
| Total insured
losses |
|
| Sixteen
states and Puerto Rico |
22.63 |
| Florida |
18.80 |
| Total number of
claims |
|
| Sixteen
states and Puerto Rico |
2.23
million |
| Florida |
1.63
million |
| Source: ISO, PCS
Unit.
| |
|
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CATASTROPHE RECORD,
2003
As of
February 2004
Date |
States
|
Perils |
Estimated
insured loss |
| |
|
FIRST QUARTER |
|
| Jan-March |
|
5 events |
$1,475 |
| |
|
TOTAL |
$1,475
(1) |
| |
|
SECOND QUARTER |
|
| Apr. 4-8 |
MO, TX, eight
other states |
Ice, snow,
freezing rain, wind, hail, tornadoes,
flooding |
$1,605 |
| Apr. 24-27 |
AL, FL, GA, MS,
TN |
Flooding, hail,
tornadoes, wind |
$60 |
| May 1-11 |
AL, AR, GA, IL,
IN, KY, MO, MS, NY, OH, OK, TN, TX |
Flooding, hail,
tornadoes, wind |
$180 |
| May 2-11 |
GA, IL, MO, NE,
NC, OK, TN, 11 other states |
Flooding, hail,
tornadoes, wind |
$3,205 |
| |
|
TOTAL |
$5,050 |
| |
|
THIRD
QUARTER
|
|
| Jul. 4-7 |
IA, IL, IN, MI,
MN, NE, OH, PA, VA, WV |
Flooding, hail,
tornadoes, wind |
$680 |
| Jul. 15-16 |
TX |
Hurricane
Claudette |
$90 |
| Jul.
21-23 |
AL, AR, FL, GA,
IL, IN, KY, MI, MS, NY, OH, PA, SC, TN |
Severe
thunderstorms |
$815 |
| Aug. 11-12 |
TX |
Flooding, hail,
tornadoes, wind |
$85 |
| Aug. 14-17 |
CT, MA, MI, NJ,
NY, OH, PA, VT |
Utility service
disruption |
$180 |
| Aug. 31-Sep.
1 |
IN, KS, MO, OH,
OK |
Flooding, hail,
tornadoes, wind |
$180 |
| Sep. 18-19 |
DE, MD, NJ, NY,
NC, PA, VA, WV |
Hurricane
Isabel |
$1,685 |
| |
|
TOTAL |
$3,715 |
|
|
FOURTH QUARTER |
|
| Oct. 14-16 |
CT, MA, ME, NJ,
NY, PA |
Flooding,
wind |
$40 |
| Oct. 24-Nov.
4 |
CA (San Diego
and San Bernardino Counties) |
Wildland
fires |
$2,035 |
| Nov. 12-14 |
IA, IL, IN, KY,
MD, MI, NJ, NY, OH, PA, VA, WI, WV |
Flooding, hail,
tornadoes, wind |
$425 |
| Nov. 16-19 |
AL, FL, GA, LA,
MO, MS, NC, OK, SC, TN, TX, VA, WV |
Flooding, hail,
tornadoes, wind |
$145 |
| |
|
TOTAL |
$2,645 |
| |
|
FULL YEAR |
|
| |
|
TOTAL |
$12,885 |
|
Note:
Catastrophes are assigned serial numbers by the
Property Claim Services division of ISO when the
insured loss to the industry resulting from an
occurrence reaches at least $25 million. This
chart identifies only the most severe
catastrophes.
Source:
ISO. | |
|
|
BACKGROUND
The insurance industry tracks
catastrophes to monitor claim costs, assigning a
number to each catastrophe. Each claim arising
from the event is tagged so that total
industrywide losses can be tabulated. The term
catastrophe is often used in the property
insurance industry in a narrow way to mean a
catastrophic event that exceeds a dollar
threshold in claims payouts. This figure has
changed over the years with inflation and the
increase in development of areas subject to
natural disasters. Thus, beginning in 1997 when
the catastrophe definition was raised from $5
million to $25 million in insured damage the
number of recorded catastrophes and the
aggregate losses attributed to catastrophes on
average is lower than in earlier
years.
While $25 million is a large
figure to most people, there have been three
catastrophes that fall into the megacatastrophe
category, greatly exceeding that amount.
Hurricane Andrew (1992) and the Northridge
earthquake (1994) were both watershed events in
that they were far more destructive than most
experts had predicted a disaster of this type
would be and the enormity of the terrorist
attack on the World Trade Center in 2001, now
estimated to cost insurers $31.7 billion,
altered insurers’ attitudes to man-made risks
worldwide.
The Destruction of the
World Trade Center: From an insurance
viewpoint, the World Trade Center disaster was
unusual. Hurricanes and other natural disasters
mostly affect personal lines companies, insurers
that sell home and auto insurance. Rarely does a
disaster seriously impact commercial lines and
life insurance companies. While many residences
were damaged by the fires and subsequent
collapse of the World Trade Center buildings,
businesses were hit hardest.
Estimates
by ISO put the cost of insured property damage
from the attacks on the World Trade Center and
the Pentagon at $18.8 billion, up from an
initial figure of $16.6 billion. Property damage
includes claims for business interruption, which
compensates for income lost when a firm is
forced to suspend business operations either due
to direct damage to the premises or because the
civil authorities cordoned off the area to
pedestrian and vehicular traffic after the
disaster, preventing entry to the premises. Also
covered, in some cases, are contingent business
interruption losses such as those due to a
firm's inability to conduct business because of
the shutdown of a major entity like an airport.
Some of the more complex claims may take years
to settle.
The number of people known to
have died as a result of the attacks on the
World Trade Center complex has been officially
set at 2,976. More than 35,000 claims totaling $
19.07 billion were filed in New York State
alone, according to the New York Department of
Insurance. Broken down by type, two-thirds were
commercial claims and one third personal, mostly
property claims. Business interruption claims,
for lost income and the expense of getting the
business back on track represented more than one
quarter of the dollars paid out. More than 5,500
business interruption and 5,600 workers
compensation claims were filed. Other claims
were paid by insurance companies to businesses
that suffered indirect losses in other parts of
the country. These were not reported to the New
York Insurance Department.
Other large
U.S. man-made disaster losses in the last two
decades include those stemming from the Los
Angeles riots in 1992, at $775 million, and the
World Trade Center bombing in 1993, at $510
million.
Hurricane Andrew:
Hurricane Andrew, which hit the Bahamas and
Southern Florida August 23-24, 1992, and then
moved across the Gulf of Mexico to strike
portions of Louisiana and other southeastern
states on August 25-26, caused $15.5 billion in
insured damage, making it the costliest natural
disaster in U.S. history. With peak wind gusts
of almost 200 mph, the hurricane flattened whole
communities, destroying thousands of homes and
businesses, battering crops and leaving in its
wake a wasteland of debris. Eleven
property/casualty insurers became insolvent due
to Hurricane Andrew (10 in Florida and one in
Louisiana) and others were financially impaired.
Some of the state’s largest homeowners insurance
companies had to be rescued by their parent
companies and others had to dig deep into their
surplus to pay Hurricane Andrew claims.
Allstate, for example, paid out $1.9 billion,
$500 million more than it had made in profits
from its Florida operations from all types of
insurance and investment income on those funds,
over the 53 years it had been in business. In
total, there were 680,239 claims including
161,400 for damage to automobiles.
The
Northridge Earthquake: The second most
costly natural disaster was the Northridge
earthquake, which caused $15.3 billion in
insured losses, according to the Institute for
Business and Home Safety (IBHS). IBHS tracks the
actual losses paid over time as opposed to ISO's
Property Claims Service (PCS), which issues an
estimate of losses following a major disaster.
PCS estimated Northridge losses at $12.5
billion. Measuring 6.8 on the Richter scale, the
quake jolted the San Fernando Valley, 20 miles
northwest of downtown Los Angeles, on January
17, 1994. The Northridge earthquake caused more
than 60 deaths, 12,000 injuries and destroyed
some 8,000 homes. More than 114,000 buildings
were damaged and some 430,000 claims were
filed.
In both natural disasters,
Hurricane Andrew and the Northridge Earthquake,
homeowners accounted for the bulk of claims and
claim dollars. The breakdown of claims for
Hurricane Andrew shows homeowners insurance
policies representing 65 percent of the total
claims; auto insurance, 25 percent; and
commercial insurance, 10 percent. The breakdown
by dollar amounts shows homeowners insurance
accounted for 73 percent of the claim dollars;
auto insurance, 2 percent; and commercial
insurance, 25 percent. Data from insurers on
claims from the Northridge quake show
residential claims at 72 percent of the total
and commercial claims at 26 percent, with
various other personal lines claims accounting
for the remainder.
Hurricanes: A
hurricane's winds revolve around a center of low
pressure expressed in millibars or inches of
mercury and the entire system moves slowly.
Hurricanes are categorized on the Saffir/Simpson
intensity scale, which ranges from 1 to 5,
reflecting a hurricane's wind and ocean-surge
intensity. Below is the Saffir/Simpson
Classification
System.
|
|
|
THE
SAFFIR/SIMPSON CLASSIFICATION SYSTEM FOR
HURRICANES
Category |
Wind
Speeds |
Pressures |
Storm
Surge |
Damage |
| 1 |
74-95 mph |
Greater than 980
mb |
4-5 ft. |
Light |
| 2 |
96-110 mph |
965-979 mb |
6-8 ft. |
Moderate |
| 3 |
111-130 mph |
945-964 mb |
9-12 ft. |
Extensive |
| 4 |
131-155 mph |
920-944 mb |
13-18 ft. |
Extreme |
| 5 |
More than 155
mph |
Less than 920
mb |
Greater than 18
ft. |
Catastrophic | |
|
|
A
windstorm becomes a tropical storm when average
wind speeds reach 39 mph. The hurricane season
runs from June 1 to November 30, but the height
of the season is from mid-August to mid-October.
Hurricane Andrew was originally tagged as a
category 4 storm and 10 years later elevated to
a category 5; but it was more like a 35-mile
wide tornado rather than a typical hurricane.
Southern Florida would have suffered even more
if Hurricane Andrew had hit a densely populated
commercial center such as Miami, 20 miles to the
north, where damage could have been more than
three times greater. If it had hit New Orleans
instead of rural Louisiana it could have left
the city under 18 feet of water. If it had
struck the New England coastline, the price tag
could have topped $110 billion.
Although
only 15 deaths were associated with Hurricane
Andrew, hurricanes in the past have caused
thousands of deaths. An estimated 6,000 drowned
in the storm that struck Galveston, Texas, in
1900. Experts say the death toll could be high
if a major hurricane hit a metropolitan area
because few communities exposed to hurricanes
have good evacuation plans. New research also
shows that in recent years most loss of life is
due to inland flooding during a hurricane rather
than storm surges along the
shoreline.
The number and severity of
hurricanes seems to run in cycles. Experts now
think these cycles are influenced by several
factors: the amount of rainfall in the Sahel
region of West Africa just below the Sahara
Desert, and the pressure and temperature
conditions there; the direction of equatorial
stratosphere winds; Atlantic Ocean and Caribbean
Sea level pressure readings; and the oceanic
warm-water pattern known as El Nino. Between
1947 and 1969, a rainy period in the Sahel, 17
major hurricanes (category 3 or greater) struck
the East Coast of the United States, compared
with 10 between 1970 and 1991, when the Sahel
was experiencing a drought. Climatologist
William Gray of Colorado State University
believes changing climatic conditions in the
tropics signal a period of more intense
hurricane activity.
Many of the most
severe hurricanes have originated near the Cape
Verde Islands off the West Coast of Africa.
Recently, hurricane experts have been studying
what has become known as the "Atlantic Conveyor
Belt," a stream of warm water that moves north
up the East Coast from Florida and loops around
to Greenland, where it cools and turns south
again. The belt of water flows at different
speeds in 20 to 30 year cycles. For the past 25
years, it has flowed slowly but is now
accelerating, creating conditions favorable to
hurricanes. Some scientists attribute the
increased hurricane activity to global warming.
Reliable records on hurricanes only go
back to the 1870s. Sketchy accounts of earlier
disasters exist in ship’s logs and journals.
Now, geologists, supported in part by insurers,
hope to add to the written record by examining
sediments at the bottom of coastal lakes and
marshes. During a hurricane, sand and shell
debris get swept into these waters. Research so
far suggests that between 1,000 and 2,000 years
ago, there were five or six category 4 and 5
hurricanes in the Florida panhandle.
Data
compiled by the National Oceanic and Atmospheric
Administration (NOAA) on the 30 most powerful
storms over the period 1900 to 1996 show that
more than 40 percent of the damage they caused
occurred in Southeast Florida. Of the 158
hurricanes that hit the United States, 47 hit
Florida and 26 of those struck the Southeast
Florida coast.
Recently, computer
simulation models have been developed that can
mesh long-term disaster information with current
demographic data to produce potential claims
losses for any given geographical location under
various scenarios. This information allows
insurers to better differentiate between high
and low risk areas in states such as Florida,
where formerly, in times of less sophisticated
risk delineation, the entire state may have been
considered high risk. In addition, computer
programs designed to help underwriters evaluate
a building's potential damage from windstorms
allow insurers to price industrial property
insurance coverages more accurately. The ability
to generate such information has also led
insurers to reassess their business strategies.
But quality and type of building
construction are not the only factors that
influence the extent of damage a windstorm can
cause. Others include the number and type of
trees in an area and the type of soil, both of
which affect the potential for losses due to
falling trees. Soft woods such as pine tend to
have shallow roots so that they are more easily
uprooted than hard woods like oak, particularly
in places with sandy soil. Storm surges will
cause more damage where the developed land is
close to sea level rather than
elevated.
Coastal Development: A
study published in 2004 by the NOAA, based on
U.S. Census data, found that in 2003, 53 percent
of the nation’s population -- 153 million people
-- lived in coastal counties (including those
that abut the Great Lakes), which in total make
up 17 percent of the country’s land mass. For
the purposes of the study, a coastal county must
be part of a coastal watershed but it does not
have to have a shoreline. These ratios have
remained steady since 1970 but the number of
people has steadily increased. Twenty-three of
the 25 most densely populated areas are coastal.
Put another way, in 1960 an average of 187
people were living on each square mile of the
U.S. coast, excluding Alaska. In 1994, that
figure was 274 per square mile and it is
expected to reach 327 people by 2015. The West
Coast is in the highest earthquake risk zone.
Between 1980 and 2003, the population of
coastal counties grew by 33 million people, or
28 percent. Florida grew 75 percent, Texas 52
percent and Virginia 48 percent. More growth is
expected. Between 2003 and 2008, the study
notes, coastal population in the Southeast
region, the area most vulnerable to windstorms,
is expected to grow by 1.1 million, or 8
percent, with the highest growth expected in the
southernmost part of Florida. Coastal counties
in the Carolinas and Georgia are also expected
to see considerable population increases. Large
Increases are forecast for the Houston, Texas
area and Florida’s central Gulf Coast. Exposure
to windstorms and high property values combine
to make Florida the state with the highest
potential for losses and New York's Long Island
the second highest.
The growth and
concentration of property values in
hurricane-prone areas has pushed to the
forefront of public policy debates the issue of
coastal development and hidden insurance
subsidies. Subsidies exist in various aspects of
the property insurance transaction. First, they
exist where rates for property insurance are no
longer commensurate with risk because it is
politically unpalatable to raise rates to
actuarially justified levels. Second, there are
subsidies in the pooling arrangements that were
set up to make sure people living along the
coast can obtain property insurance. When these
pools have insufficient funds to pay claims, the
shortfall is picked up by insurance companies,
which may then pass the cost on to all property
insurance policyholders in the state through
explicit policy surcharges, as in Florida, or in
the form of higher property insurance rates.
In the past few years, insurers have
sought to make people who live in areas
vulnerable to natural disasters pay more of
their fair share of the cost of catastrophes by
creating higher deductibles for natural disaster
damage. These deductibles, which exist in
regions prone to hail as well as hurricane
damage, are generally equal to a percentage of
the structure's insured value. Seventeen states
and the District of Columbia have hurricane
deductibles. In Florida rates for windstorm
coverage are now based on the structure's
ability to withstand damage by high winds,
calculated using computer models, instead of the
likelihood of fire damage.
Earthquakes: On the West Coast,
earthquakes represent the greatest threat.
Statistics show that since 1900 earthquakes have
occurred in 39 states and have caused damage in
all 50. About 5,000 quakes can be felt each
year, with some 400 capable of causing damage to
the interior of buildings and 20 capable of
causing structural damage. A major earthquake
(8.2 on the Richter scale) in San Francisco
could cause as much as $84 billion in damage.
However, a major earthquake on the East Coast,
though more unlikely, could cause much greater
damage. Because earthquakes in the eastern part
of the country tend to be thrust-fault quakes,
which produce an up-and-down motion rather than
the horizontal side-to-side common in
California, damage could be 10 times greater,
according to seismic experts. The degree of
damage also depends on other variables such as
the structure of the building and soil
conditions (see Earthquake paper).
A
study by Dr. Haresh Shah of Risk Management
Solutions and Stanford University, which draws
on data from the 1994 Northridge quake and the
1995 quake in Kobe, Japan, suggests the ground
shaking at a quake's epicenter can be more
violent than expected. This finding has pushed
up earlier estimates for loss of life and
property damage in the event of a megaquake. An
8.3 magnitude quake in San Francisco, the same
in intensity as the quake in 1906, could cause
up to 8,000 deaths and between $80 and $105
billion in insured losses, with total losses as
high as $225 billion. (Total damage from the
Kobe, Japan quake was $147 billion, of which
only $4.1 billion was insured.) New estimates of
the potential damage to Tokyo in a major
earthquake are numbing. A quake similar to the
one that destroyed the city in 1923 could cause
as much as $4.3 trillion in total
losses.
California insurers collected
only $3.4 billion in earthquake premiums in the
25-year period prior to the Northridge
earthquake and paid out more than $15.3 billion,
more than four times that amount, on Northridge
claims alone (data from the Institute for
Business and Home Safety). After the Northridge
earthquake, insurers were reluctant to offer
homeowners insurance because they feared
additional earthquake exposure could potentially
bankrupt them. In response to this crisis in the
homeowners insurance market, in 1995 California
lawmakers passed a two-part bill that allowed
insurers to offer a new earthquake policy with a
maximum deductible of 15 percent and created a
privately funded, state-run earthquake pool.
Earlier in that year, the Southern California
Earthquake Center had revised its projections of
the chance of a magnitude-7 or larger earthquake
hitting Southern California to 86 percent within
the next 30 years. New estimates show a lower
risk.
Earthquake Insurance:
Insurers doing business in California must offer
earthquake insurance to their homeowners
insurance policyholders, either a policy from
the California Earthquake Authority (CEA) or, if
they do not participate in the pool, a policy
that they underwrite. Several dozen companies
now write earthquake insurance in California in
addition to the CEA. The CEA became operational
in December 1996, with a $10.5 billion funding
package after the Northridge earthquake caused
home insurers to cut back on new homeowners
policies to reduce their earthquake exposure.
The CEA could now pay claims caused by a quake
more than twice as destructive as Northridge
since with each passing earthquake-free year,
its claims-paying ability increases. Passage of
the CEA legislation opened up the homeowners
market (see Earthquake paper). More recently,
the CEA created a supplementary policy to
broaden coverage. Nevertheless, only a small
portion of the state’s property owners buy
earthquake insurance and the percentage appears
to grow smaller as the time span since the last
major quake increases.
Tornadoes:
Hurricanes are not the only windstorms to which
people living in the United States are exposed.
Each year, about 1,200 tornadoes with wind
speeds as high as 300 mph touch down in the
United States. Though potentially not as
damaging as hurricanes, tornadoes are more
frequent. They can cause severe damage over a
small area and, before the advent of tornado
warnings, many deaths. In the decade 1965-1974,
they were responsible for an average of 141
deaths each year, compared with 60 in the 10
years 1994-2003. In 2003, 155 tornadoes hit
Texas, 119 touched down in Illinois, 92 hit
Kansas and 81 struck Missouri, Nebraska and
South Dakota. Among these states, which reported
the highest number of tornadoes, only Kansas and
Missouri reported a high number of deaths — 11
and 16 respectively. Overall, in 2003, 1,376
tornadoes hit 41 states, killing 54 people. The
peak of the tornado season is April through June
or July. Spring tornadoes tend to be more severe
and strike the Southeast, which is more densely
populated than the Great Plains, thus causing
more deaths than those in the summer months. In
addition, the South has more mobile homes than
other regions. Mobile homes are vulnerable to
tornado damage.
Since 1990 the number of
tornadoes has generally exceeded 1,000 a year.
In the three preceding decades, the only year in
which there were more than 1,000 tornadoes was
1973, when 1,102 were reported. This increase
may reflect greater ability to detect
tornadoes.
Reinsurance: Just as
individuals and businesses buy insurance to
protect their assets, primary insurers, the
companies that sell insurance to consumers, buy
reinsurance to protect their bottom line.
Reinsurance is sold in layers, reaching up into
the millions of dollars to protect insurance
companies from possible, but statistically
highly unlikely events, such as a $100 million
court award or an extraordinary number of
homeowners claims as a result of a hurricane or
a fast-spreading brush fire.
Until
Hurricane Andrew, insurers had assumed that the
largest possible catastrophe would cost the
insurance industry about $8 billion. Based on
that figure and an insurer’s market share, a
primary insurer would work out a reinsurance
program to protect against a megacatastrophe. An
insurer with a 3 percent market share, for
example, might decide to assume (retain) the
first $30 million in losses — essentially its
deductible — and buy catastrophe reinsurance to
protect it up to $200 million.
Retentions
and coinsurance, through which insurers share
the risk at various levels with their
reinsurers, as well as coverage amounts, have
increased dramatically since Hurricane Andrew.
It is now patently evident that the cost of
catastrophes, both natural and man-made, can be
in the tens of billions of dollars. While
insurers have adjusted to a new era in natural
disasters, the terrorist attack on the World
Trade Center challenged assumptions about
man-made losses. Before September 11, terrorist
coverage was provided to commercial
policyholders virtually without charge because
the risk of an attack was considered so low.
Immediately following the disaster, reinsurers
said they would no longer offer terrorist
coverage to the insurance companies they
reinsure because they could not price this
unprecedented risk and coverage for terrorist
events is still limited. Legislation that made
the federal government the reinsurer of last
resort for major terrorist attacks was passed by
Congress in November 2002, making it easier for
insurers to calculate maximum losses and
therefore to price the coverage. Currently, the
federal program ends in 2005.
The
shortage of catastrophe reinsurance capacity in
the United States, following Hurricane Andrew,
particularly for large national insurance
companies, also prompted insurers, reinsurers,
investment banks and others to look for new ways
to spread the risk of natural disasters (see
Reinsurance paper). Increasingly, the capital
markets are being seen as a large resource that
can be tapped to cover claims at the higher
levels (after reinsurance has been exhausted)
where there is a low probability of loss. The
advantage to investors is diversification.
Catastrophe losses are unrelated to the usual
speculative risks, which are generally economic.
While the number of transactions involving the
capital markets is still relatively small, some
observers expect catastrophe risk to be
securitized and made available to investors on a
regular basis, with a robust market for these
securities developing over the next decade or
so.
Pricing: The price of an
insurance policy reflects the costs of paying
claims covered by that policy, as well as an
insurance company's costs for such items as
reinsurance. For example, if a community has a
good fire department then serious fires in that
community will likely be few, relative to other
communities that lack a good fire department but
are otherwise similar. As a result, fire
insurance premiums in that community will be
lower. The same principle applies to windstorms:
premiums will reflect the normal level of
windstorm claims in a given community.
How does the insurance industry deal
with extraordinary costs such as the $15.5
billion bill for Hurricane Andrew? Prior to
Hurricane Andrew, insurance companies accounted
for hurricanes and other catastrophes with a
special premium amount known as a "catastrophe
loading." Using catastrophe data spanning 30 to
40 years to spread the cost of catastrophes over
a long time period, and sometimes using data
from several states subject to the same kind of
catastrophes, they developed the average annual
cost of catastrophes. Before Hurricane Andrew,
the catastrophe loading for Florida homeowners
averaged $50. This translated into 14 percent of
the $366 average Florida homeowners premium at
that time.
However, since then, more
sophisticated computer modeling techniques have
become available. Many insurers are now basing
their rates on meteorological data combined with
their own exposure data. The meteorological data
show the probability of a natural disaster
occurring in a particular geographical area and
the exposure data indicate how many of the
company's policyholders are likely to be
affected and to what extent, i.e., what the
insurer's potential losses from that event are
likely to be. Models are also being created to
assess the losses a specific company or building
might sustain in a terrorist attack.
Catastrophe Deductibles: After
Hurricane Andrew, with computer-based models of
storms, coastal development patterns and
increasing values all indicating how vulnerable
insurers were to large weather-related losses,
homeowners insurers had difficulty finding the
reinsurance coverage they needed to protect
their own bottom line. Many homeowners insurers
couldn't obtain reinsurance coverage unless they
agreed to greatly reduce their potential maximum
losses from such events through higher
deductibles. Insurers in catastrophe-vulnerable
states may now require percentage deductibles on
homeowners insurance policies for wind damage
losses, as opposed to a dollar deductible, to
limit their exposure to catastrophic losses from
natural disasters.
Percentage
deductibles for windstorm and hail losses, which
may be mandatory in some coastal areas of a
state, vary from 1 percent of the home's insured
value to 15 percent, depending on many factors
that differ from state to state, and sometimes
from insurer to insurer, including the home's
insured value and the "trigger," the nature of
the event to which the deductible applies. In
some states, policyholders have a "buy back"
option — paying a higher premium in return for a
traditional dollar rather than percentage
deductible. The percentage deductibles may apply
to the entire state or just part of it (see
Hurricane and Windstorm Deductibles
paper).
Along with windstorms, hail
storms can also cause catastrophic losses. In
Texas, the insurance department has set up a
Market Assistance Plan (MAP) to help homeowners
in areas where insurance may not be readily
available, including hail-prone regions. MAPs
are programs designed to put people having
difficulty obtaining insurance in touch with
insurers willing to accept more business.
Insurers are allowed to offer higher deductibles
for claims associated with wind, hurricanes and
wind-driven rain — up to 5 percent of a home's
insured value — with premium discounts of up to
16 percent. The change addresses availability
problems in the disaster-prone parts of the
state. The same range of deductibles is
available for fire and other property losses
with premium reductions of up to 22 percent.
Data for 2002, the latest available, show that
Texas already has the highest average homeowners
premium ($1,238) in the nation.
In
Colorado, insurers have increased deductibles
for wind and hail and in some hail-prone parts
of Texas, Kansas, Kentucky and other Midwestern
states. In addition to raising deductibles, some
companies are providing coverage for roofs on a
depreciated (actual cash value) basis, rather
than replacing a damaged roof with a new one, to
keep rates affordable. In Arkansas, legislation
has been passed to set up an Earthquake MAP. If
the MAP fails to solve the need for earthquake
insurance, an Arkansas Earthquake Authority,
funded initially by insurers, would be formed to
issue policies.
Special Catastrophe
Programs: In addition to the risk of natural
disasters, the insurance industry now faces the
risk of terrorist attacks. The destruction of
the World Trade Center and other losses on
September 11, 2001 are now expected to total
$31.7 billion, including liability and life
insurance claims.
The Terrorism Risk
Insurance Act of 2002 (TRIA) authorized the
creation of a three-year federal reinsurance
program, which is triggered when terrorism
losses exceed a predetermined amount. The
program enabled the commercial insurance market
to function even though the threat of terrorism
remains. TRIA requires individual insurance
companies to pay in years one, two and three the
equivalent of seven, 10 and 15 percent,
respectively, of their earned commercial
insurance premium, including workers
compensation. In 2004, the per company
deductible or retention is 10 percent and the
overall industry retention is $12.5 billion, up
from $10 billion in losses in the first year of
the program. In 2005, the last year, it rises to
$15 billion. The federal government will pay 90
percent of losses above the per company or
overall industry maximum payment level, up to a
maximum liability for the total program of $100
billion per year.
During discussions in
the House on the specific provisions of the
legislation, there was general agreement that
some of the payments made by the federal
government should be in the form of loans. As a
result, if a terrorist act triggers federal
funds because losses have exceeded the
individual company threshold but total industry
payments, including the industry’s 10 percent
share of losses above that total, are less than
the industry’s maximum, then the industry must
impose a commercial policyholder surcharge of up
to three percent of premium to fund the
repayment program. Personal lines insurance
companies and reinsurers are not covered by
TRIA. In return for the federal backstop,
insurers must make terrorism coverage available
and conspicuously state the premium charged but
policyholders may reject the offer.
In
the United States, special pools, known as Beach
and Windstorm Plans, ensure the availability of
windstorm insurance for properties close to the
ocean. These pools, which exist in seven states
along the Gulf and Atlantic coasts in various
forms, are operated by property insurers doing
business in the state. Hawaii also created a
fund but this was disbanded in December 2000.
New Zealand, Japan, France, Norway and
the Netherlands also have catastrophe programs.
The original program in New Zealand, the
Earthquake and War Damage Commission, was
enacted in 1944 to cover "uninsurable" risks.
Since 1994, the program has covered not only
damage caused by earthquakes but also floods,
tsunamis, landslides, volcanic eruptions and
hydro-thermal activity. Funding comes from a
levy placed on all fire insurance
policies.
In France, the government
created a program in 1982 to pay for uninsurable
disasters such as floods. It is funded through a
tax on nonlife insurance premiums. Insurance
companies can obtain reinsurance for
catastrophes from the government-owned Caisse
Central de Reassurance. After the World Trade
Center disaster in 2001, it agreed to pay claims
for terrorist attacks that cause more than 1.5
billion euros in damage in any year. The
Netherlands set up a natural disasters program
based on the French system after widespread,
devastating flooding in 1994.
Japan has
had an earthquake program covering residential
properties since 1966. Primary companies sell
the coverage but, since it is expensive and not
mandatory, less than 10 percent of homeowners
purchase it. Primary insurers insure 100 percent
of the risk with the Japanese Earthquake
Reinsurance Company (JER), a government entity.
JER in turn cedes a portion of the risk to the
private reinsurance market and to the Toa
Reinsurance Company. The program requires a high
level of "coinsurance" by policyholders. In the
case of "half a loss," for example — damage
equal to between 20 and 50 percent of the
property's value — only 50 percent of the loss
is covered by insurance. The total limit of
indemnity payable by all insurers to claimants
for any one earthquake is set annually by the
Japanese government. If claims exceed the
budgeted amount, payments are prorated. The
government limits commercial insurance coverage
for earthquakes by geographical location,
according to the risk of earthquake damage.
Taiwan set up a program for earthquake losses in
2002 under which claim costs will be shared
among private insurers, the international
reinsurance industry and the government.
Great Britain has a program that
provides terrorist coverage. The government
formed a mutual reinsurance pool for terrorist
coverage in 1993, following acts of terrorism by
the Irish Republican Army. Insurance companies
that are members of the pool sell coverage to
their policyholders at rates set by Pool Re,
which vary according to which of four zones the
property is in. The insurer pays the entire
claim for terrorist damage but is reimbursed by
the pool for losses in excess of a certain
amount. Following the World Trade Center
disaster in 2001, Pool Re coverage was extended
to cover all risks including nuclear and
biological contamination, aircraft impact and
flooding if caused by terrorist attacks.
Australia now has a reinsurance pool to backstop
insurance company terrorism losses and Singapore
is considering one.
Spain has a
government sponsored reinsurance pool that
covers both terrorist acts and natural
disasters, such as floods, but does not offer
business interruption coverage. The original
need for terrorist coverage stemmed from acts of
violence carried out by the Basque separatist
movement, which has been active in Spain for
many years. Private insurers may provide
catastrophe coverage but they are still required
to make payments to the pool. As with the
British program, property rates are established
by the pool. In Germany, the government has
agreed to provide coverage for terrorist damage
but will not accept unlimited liability.
Flood Insurance: Flood damage is
excluded under homeowners policies, but it is
covered under the comprehensive section of
standard auto insurance policies and some
coverage is available for floods under special
commercial insurance policies. Some insurance
companies provide coverage under homeowners
policies for the back up of sewers and drains.
Flood insurance for homeowners and
businesses is available from the federal
government. The private sector cannot insure
floods because only people concentrated in
flood-prone zones would purchase flood insurance
and those people would have frequent claims,
making the coverage prohibitively expensive.
Before Congress passed the National Flood
Insurance Act in 1968, after Mississippi River
flooding, the national response to flood
disasters had been to build dams, levees and
other structures to hold back flood waters, a
policy that may have encouraged building in
flood zones.
The National Flood
Insurance Act was amended in 1969 to provide
coverage for mudslides and again in 1973. This
last amendment put constraints on the use of
federal funds in flood plain areas unless the
property was protected by flood insurance, a
provision that was expected to make coverage in
flood plains almost universal. No lenders that
are federally insured or financed can lend money
on a property in a flood plain zone when a
community is participating in the National Flood
Insurance Program (NFIP) unless the property is
covered by flood insurance.
Flood
insurance is only available where the local
government bodies have adopted adequate flood
plain management regulations for their flood
plain areas under the NFIP. Buildings
constructed in a flood plain after a community
has met regulations must conform to elevation
requirements. About 20,000 communities
participate in the program. When repair,
reconstruction or improvement to an older
building equals or exceeds 50 percent of its
market value, the structure must be built to
code. Older buildings sustain six times more
damage than newer, elevated buildings built to
flood-plains management standards, according to
the Federal Insurance
Administration.
Legislation was enacted
in 1994 to tighten enforcement of flood
insurance requirements. Regulators can now fine
banks with a pattern of failure to enforce the
law and lenders can purchase flood insurance on
behalf of homeowners who fail to buy it
themselves, then bill them for coverage. The law
includes a provision that denies federal
disaster aid to people who have been flooded
twice and have failed to purchase insurance
after the first flood. Another provision allows
homeowners the option of purchasing flood
mitigation insurance, coverage similar in
concept to an ordinance or law endorsement, to
help pay the cost of raising a structure above
flood level to meet federal flood requirements.
Flood insurance was initially only
available through insurance agents who dealt
with a firm under contract with the Federal
Insurance Administration (FIA), part of the
Federal Emergency Management Agency, to provide
administrative services and maintain records.
The "direct" policy program has been
supplemented since 1983 with a program known as
"Write Your Own," through which some 85
insurance companies issue policies and adjust
flood claims on behalf of the federal government
under their own names. The insurers receive a
commission and remit premium income in excess of
claims to the federal government. The FIA pays
losses in excess of premiums and sets the rates,
coverage limitations and eligibility
requirements, and designates flood plain areas.
The NFIP is expected to be self-supporting
(i.e., premiums are set at an actuarially sound
level) in an average loss year, as reflected in
past experience.
Flood plain maps are
redrawn periodically. As development in and
around flood plains increases, run off patterns
change, causing flooding in areas that were
formerly not considered high risk. In addition,
new technology enables flood mitigation programs
to more accurately pinpoint areas vulnerable to
flooding. Since the inception of the federal
program, some 25 to 30 percent of all paid
losses were for damage in areas not officially
designated at the time of loss as
flood-prone.
Flood insurance covers
direct physical losses by flood and losses
resulting from flood-related erosion caused by
waves or currents of water exceeding anticipated
cyclical levels and accompanied by a severe
storm, flash flood, abnormal tide surge, or a
similar situation which results in flooding.
Buildings are covered for replacement cost but
coverage for personal possessions is available
on an actual cash value basis only. Coverage for
the contents of basements is limited. To prevent
people putting off the purchase of coverage
until waters are rising and flooding is
inevitable, policyholders now have to wait 30
days before their policy takes effect. In 1993,
7,800 policies purchased at the last minute
resulted in $48 million in claims against only
$625,000 in premiums.
More than 11
million U.S. homes are in flood zones. Only
about one in four homeowners who live in areas
vulnerable to floods purchase federal flood
insurance from the NFIP, generally those in the
highest risk areas, in part because people
underestimate the risk of flood damage. They
tend to think the risk of flooding for
structures in a flood zone is about the same as
the risk of fire, when in fact it is much
higher. According to a Federal Emergency
Management Agency probability analysis, over the
life of a 30-year mortgage, a property located
in a special flood hazard area would have a 26
percent chance of being flooded, compared with a
1 percent chance of suffering a fire loss. The
typical policy costs about $416 for $15,000 in
coverage.
Data from the Federal
Insurance Administration show more people are
purchasing flood insurance. Ninety percent of
all natural disasters in this country involve
flooding, according to the National Flood
Insurance Program.
Building Code
Enforcement and Other Damage Mitigation
Measures: In the mid-1980s, a study of the
damage caused by Hurricanes Alicia (1983) and
Diana (1984), two storms of roughly equal size
and intensity, found that the level of building
code enforcement affected the cost of claims.
Hurricane Alicia hit Texas, causing $675 million
in insured damage, of which close to 70 percent
was attributed to poor code enforcement. By
contrast, Hurricane Diana hit North Carolina,
where codes were effectively enforced.
Researchers found that only 3 percent of homes
in that state suffered major structural damage
as result of the hurricane. (Insured losses for
North and South Carolina totaled $36 million.)
This research and a similar assessment of losses
in South Carolina after Hurricane Hugo prompted
the National Committee on Property Insurance,
now the Tampa-based Institute for Business and
Home Safety (IBHS), to study coastal municipal
building code departments in Southern states.
Researchers found that building officials and
inspectors in about half of the communities
surveyed were not enforcing the building code
wind-resistance standards, on their
books.
In South Florida, which has one of
the strongest building codes in the country,
experts estimated that between 25 and 40 percent
of Hurricane Andrew losses were avoidable. A
Dade County, Florida Grand Jury report issued in
December 1992 confirmed that much of the damage
was due to lax code enforcement, warning that it
was a long-standing problem in the state and
that the quality of rebuilding in the
hurricane-devastated area might be even lower.
As a result, the insurance industry
began to develop a building code compliance
rating system, similar to its fire protection
rating system, which dates back to 1916. Under
this classification program, each local fire
department's fire-fighting capability is ranked
according to various factors, such as water
supply and whether its fire fighters are
full-time paid employees or volunteers. The
final ranking is incorporated into the homeowner
premium rate structure. The ranking process
takes into account such things as the size of
the building code enforcement budget relative to
the amount of building activity, the
professional qualifications of building
inspectors and past code enforcement, levels,
with special emphasis on mitigating losses due
to natural disasters. Insurers can now offer
discounts on property insurance for new
construction in communities that enforce
accepted building codes. Communities are
regraded for building code enforcement every
five years. Losses caused by the 2004 hurricanes
highlight the value of stronger codes. Most of
the severely damaged structures were built
before Hurricane Andrew.
After Hurricane
Andrew, the insurance industry created an
organization, the Institute for Business and
Home Safety (IBHS), designed to bring the same
level of technical expertise to property losses
as the Institute for Highway Safety has brought
to automobile losses. Through IBHS, insurers are
now sponsoring building construction that better
withstands natural disasters. Named
"Fortified…for Safer Living," the program
specifies construction, design and landscaping
guidelines for homes and eventually businesses
in areas subject to windstorms, hailstorms and
earthquakes. The current program applies to
homes now being built. There will also be a
retrofitting program for existing structures.
The aim is to have a fortified model home in
every county in Florida and then one in every
state. In Florida, such houses cost from 4 to 9
percent more to build. Surveys show that on
average people are prepared to pay up to 6
percent more for a disaster-resistant dwelling.
The concept behind this program is twofold: to
keep the structure intact and to protect those
inside from outside debris, which turns into
dangerous missiles in a storm. The more secure
the structure, the less storm-generated debris
there will be. In addition, IBHS has worked to
develop a hail map using hail loss data. It will
be used to indicate where hail resistant
construction should be
mandated.
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