How do catastrophes affect the insurance industry

The hurricane season runs from June 1 to November 30, but the height of the season is from mid-August to mid-October. The number and severity of hurricanes seems to run in cycles. Experts now think these cycles are influenced by what is known as the Tropical Multi-Decadal System. Since conditions have been favorable for increased hurricane activity, as they were during another active period, Three climatic factors are thought to influence the development of hurricanes.

First, during an active period the amount of rainfall during the monsoon season in the Sahel region of West Africa just below the Sahara Desert is higher than average, and rainfall is lower than average over the Amazon basin, creating favorable conditions for winds associated with the development of hurricanes.

Second, sea-surface temperatures in the tropical Atlantic Ocean and Caribbean Sea are very warm. Third, La Nina causes lower than average sea-surface temperatures in the equatorial Pacific. Between and , 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 and , when the Sahel was experiencing a drought.

New research suggests that the degree of hurricane activity in the Atlantic Basin is not a proxy for the number of storms that are going to make landfall along the U.

Genesis patterns change from year to year. The key to understanding why in some years the number of storms making landfall in the United States is high and in others it is low is to compare long-term genesis and storm tracking patterns, the AIR study notes. Florida is the state most vulnerable to hurricanes.

Reliable records on hurricanes only go back to the s. 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, and 2, 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 to show that more than 40 percent of the damage they caused occurred in southeast Florida. Of the 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: In , Bureau of the Census.

The U. The Atlantic region was the most populated of the three coastal regions, with counties where The Pacific region was the second most populous, with 70 counties, The counties along the Gulf of Mexico was the smallest coastal region, with 56 counties, Counties along the Gulf of Mexico grew the fastest between and , where the population grew In counties along the Pacific Coast, population grew Noncoastline county population grew at about the same rate as the total United States, at 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 may be 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 indirectly in the form of higher property insurance rates.

Third, the federal flood insurance program has paid out millions of dollars to rebuild structures in high-risk zones known as repetitive loss properties, where the cost of claims over the years may have totaled much more than the home was worth.

According to CoreLogic, storm surge is ocean water that is pushed ahead of a storm and can cause severe damage. States along the U. Gulf of Mexico and Atlantic Basin are potentially vulnerable to storm surge damage. The latest CoreLogic report shows that in , there were 7. Along the Gulf Coast, 3.

The reconstruction cost is based on the percent destruction of the residential structure, using a combined cost of construction materials, equipment and labor costs by geographic location.

Category 1 represents the higher risk of damage from a weak hurricane; Category 5 includes Categories 1 to 4 and the low risk of damage from a Category 5 hurricane.

View Archived Tables 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.

These deductibles exist in regions prone to hail as well as hurricane damage. Eighteen states and the District of Columbia have what have become known as hurricane deductibles. Percentage deductibles for windstorm 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 or portions of a state, 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. For hail damage, in addition to instituting percentage of limits deductibles, some insurers in some states are providing coverage for roofs on a depreciated actual cash value basis, rather than replacing a damaged roof with a new one.

Some are offering a discount for hail- resistant roofs or imposing a surcharge for roofs that are not hail resistant to encourage people to replace old roofs with new, less damageable ones. Earthquakes: On the West Coast, earthquakes represent the greatest threat.

Statistics show that since , earthquakes have occurred in 39 states and have caused damage in all About 5, quakes can be felt each year, with some capable of causing damage to the interior of buildings and 20 capable of causing structural damage.

A repetition of the San Francisco 7. 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 Earthquakes: Risk and Insurance Issues paper. 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 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.

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 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. Tornadoes: Each year, about 1, tornadoes with gusts of wind as high as mph touch down in the United States.

Tornado intensity is measured by the Fujita scale, which runs from 0 through 5, the most damaging, based on the maximum speed of three-second wind gusts and the potential for damage.

The scale incorporates 28 different damage indicators based on damage to a wide variety of structures from shopping malls to trees. Though generally not as costly in terms of insured values as hurricanes because they strike a more limited geographic area, tornadoes are more frequent.

They can cause severe damage and, particularly before the advent of tornado warnings, many deaths. In the decade they were responsible for an average of deaths each year, compared with in the 10 years This average was pushed up by the unusually high number of deaths in 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 the number of tornadoes has generally exceeded 1, a year. In the three preceding decades, the only year in which there were more than 1, tornadoes was , when 1, were reported. This increase may reflect greater ability to detect tornadoes. Wildland Fires: Fire plays an important role in the life of a forest, clearing away dead wood and undergrowth to make way for younger trees.

But for much of the last century, fire-suppression policies focused on extinguishing wildfires as quickly as possible to preserve timber and, increasingly, real estate. These policies have led to the accumulation of brush and other vegetation that is easily ignited and serves as fuel for wildfires. In recent years, most of the large fires with significant property damage have occurred in California, where some of the fastest developing counties are in forested areas.

However, wildfires are a growing threat in other states, particularly when there is a drought, as more homes are built in woodland areas that were once wild. Over the past decade, the number of acres burned has increased as drought, record-setting heat and the build-up of dead trees and undergrowth together with residential development have combined to heighten the risk of fire. According to a University of Wisconsin study, in the West more than 8. A scientific study published in the September 4, issue of the Proceedings of the National Academy of Sciences examined the role houses play in the spread of wildfires.

It found that making entire neighborhoods of homes fire resistant slows down the spread of fire. The likelihood of fires spreading from one site to another is dictated in large part by the amount and proximity of fuel—flammable materials such as dry undergrowth, trees that burn easily and unprotected wooden structures.

When houses are not fire resistant, they add greatly to the fuel load and potential for the fire spreading because they quickly burn down to the ground. When homes are fire resistant, not only are they less likely to burn but they also act as a fire break, reducing the ultimate size of the fire and enabling it to be brought under control more easily.

Fire damage is covered under a homeowners insurance policy whatever the cause of the fire, unless the person insured under the policy commits arson by intentionally setting fire to the structure. As a result of the greater potential for fire losses where homes are built on mountainous and forested sites, insurers are increasingly requiring homeowners whose property is at risk to take precautions to slow the spread of fire.

Building Code Enforcement and Other Damage Mitigation Measures: In the mids, a study of the damage caused by Hurricanes Alicia and Diana , two storms of roughly equal size and intensity, found that the level of building code enforcement affected the cost of claims. 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.

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 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 Under the fire protection classification program, each local fire department's firefighting capability is ranked according to various factors, such as water supply and whether its firefighters are fulltime paid employees or volunteers. The final ranking is incorporated into the property insurance premium rate structure.

The building code enforcement 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. Named "Fortified…Home," 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 is also a retrofitting program for existing structures. 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. Efforts to reduce catastrophe damage are not confined to hurricane-prone regions. Homes in areas vulnerable to other types of catastrophes can be protected also and even if discounts are not offered, hail and wildfire-resistant roofs and measures taken to reduce earthquake-related damage make structures in high-risk areas more readily insurable, and because there is generally less damage, lessen the frustrations involved in getting back on track after a disaster.

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. Retentions and coinsurance, through which insurers share the risk at various levels with their reinsurers, as well as coverage amounts have increased dramatically over the past decade.

It is now patently evident that the cost of catastrophes, both natural and man-made, can be in the tens of billions of dollars. Before September 11, terrorist coverage was provided to commercial policyholders essentially without charge because the risk of an attack was considered remote. 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.

Legislation that made the federal government the reinsurer of last resort for major terrorist attacks was passed by Congress in November and extended in for two more years, making it easier for insurers to calculate maximum losses and therefore to underwrite the coverage see paper on Terrorism Risk and Insurance.

The program was reauthorized by Congress at the end of for another seven years. 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.

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. Not surprisingly, reinsurance costs as well as direct claims costs are lower where the risk is low. For example, if a community has a good fire department and ready access to water to extinguish fires, serious fires in that community will likely be fewer than in similar communities that lack a good fire department.

The same principle applies to windstorms: premiums will reflect the normal level of windstorm claims in a given community.

Prior to Hurricane Andrew, insurance companies accounted for hurricanes and other catastrophes with a special premium amount known as a "catastrophe loading" to spread the risk over a period spanning 30 to 40 years. Sometimes they used data from several states subject to the same kind of catastrophes to develop the average annual cost of catastrophes.

However, since the mids more sophisticated computer modeling techniques have become available. Insurers now base their rates, in part, on sophisticated computer models that combine meteorological data 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.

Models can also assess the losses a specific company or building might sustain in a terrorist attack. Insurance for High Risks: The risk of flood, earthquake or landslide damage is not covered under the typical property damage policy. Because the nature of the risk is different, insurers have created special policies. With auto and homeowners insurance, a very large number of people are exposed to the same risks but only a random few in any geographic area ever experience a loss.

Issue: The economic cost of natural disasters has an immense impact on the U. In terms of insured losses, 10 of the nation's costliest catastrophes have occurred in the past two decades. Eight of these were hurricanes. Insurance plays a large part in helping with the economic recovery following catastrophic events.

Background: Flood damage is a major source of uninsured losses for two reasons:. Rising flood risks and the uncertain financial future of the National Flood Insurance Policy NFIP underscore the importance of growing the private flood insurance market.

The NAIC adopted a best practices document to help facilitate the private flood insurance market. Recent advances in risk mapping and modeling have also helped the emerging private market grow by enabling private insurers to more accurately price risk.

However, the definition and prescriptive conditions present a hindrance to the private market. The growing frequency and severity of natural catastrophes warrant greater focus on resiliency. The survey asks eight questions that assess insurer strategy and preparedness in the areas of:. The survey is currently administered on a mandatory and public basis through a multi-state effort led by California. Currently, the Center for Insurance Policy and Research CIPR is assessing the climate data to provide more in-depth information about how insurance companies are responding to climate change.

A report analyzing the survey's quantitative data PDF was released in November There has also been increased global engagement in the insurance sector on resiliency to climate-related risks.

Likewise, in , the European Commission presented its Action Plan on Sustainable Finance, underlining the importance of involving the finance industry in climate change mitigation.

Additionally, insurance supervisors began examining the impact of climate change through the Sustainability Insurance Forum SIF in In , the SIF released a statement in support of the TCFD recommendations and implemented a survey process for supervisors to share their efforts to address climate risks. Status: The rising likelihood of extreme and catastrophic weather events makes monitoring the frequency and impact of natural disasters a critical regulatory function.

NAIC members have taken an active role in educating Congress and providing technical feedback on various proposals regarding natural catastrophes. Over the last several years, NAIC members have met with members of Congress and have testified on these important issues, stressing the role of the states in effectively managing a natural disaster response.

The Working Group is charged with:.