Insurance Industry Challenged by Unexpected Weather

Article

It’s a tough time to be in the $500 billion U.S. property insurance business. Storms are happening in places they never happened before, at intensities they have never reached before and at times of year when they didn’t used to happen.

Those bizarre weather patterns damage not just homes but also insurance companies’ financials. If seas rise and houses flood, insurers pay. If winds shift and buildings blow down, they also pay. If temperatures rise and crops fail, same thing.

The industry hasn’t reached a consensus on what’s causing weird weather.

“It’s hard to really deny that global warming exists,” said Karen Clark, chief executive of Boston-based Karen Clark & Co., which helps insurance companies forecast natural disasters. “You can accept that and that’s fine, but that doesn’t mean we can quantify the impacts.”

Others in the business are reluctant to assign blame to broader trends. “Our view would be it’s too early to come to a conclusion,” said Liam McGee, chief executive of the Hartford Financial Services Group.
What no one disputes is that the storms the industry expects aren’t happening and the ones they don’t expect are hitting them hard.

The implications are profound for consumers as well as insurers. If hundred-year storms are now at risk of happening every 40 years or every three, it is difficult to know how much property insurance should cost.

The last couple of months underscore just how much climate seems to be changing. Queensland state in Australia has suffered a virtual apocalypse — flooding in December, flooding in January and tropical cyclones in February that inundated at least 30,000 homes and crippled the local coal industry.
Meanwhile in the United States, snow fell on Christmas Day in a number of southern cities for the first time since at least the 1880s. Los Angeles got six months’ worth of rain in three weeks, causing some of the worst flooding in the state’s history. The New York metropolitan area had an unprecedented blizzard the day after Christmas and a month later got almost the same, breaking historical records.

Private weather service AccuWeather, in a blog entry on its website two days before the Christmas blizzard in New York, asked its forecasters for their take on the sophisticated, expensive new computer models used to predict the path and behavior of the storm. The forecasters’ collective answer, according to the blog: “None of them are right.”

Worldwide, insurers suffered at least $36 billion in catastrophe losses in 2010, according to Swiss Re — the fourth-highest total of the last decade, and the highest if years with major hurricane landfalls are excluded. But this year, as with last year and the year before, what insurers are seeing is the unexpected. That means both storms going where they’re not supposed to as well as a spate of totally unexpected losses at entirely unpredicted times of year.

“Some people believe that is because weather patterns have changed. I happen to be in that camp,” said Tom Wilson, the chairman and chief executive of Allstate, the largest publicly traded property insurer in the country. “I just don’t think it should happen three years in a row.”

One of the biggest problems for insurers is that they have to insure increasingly valuable properties in risky areas that, by and large, are not being built with disaster risk in mind. That in and of itself is driving their risk up dramatically. In most places, no one stopped to think whether building the houses was a good idea, or whether there were appropriate building codes in place.

“Even if the baseline of activity from a natural hazards point of view stays constant, the level of losses you’re going to see will certainly be increasing commensurate to the increases in economic activity and national wealth,” said Bill Keogh, president of Eqecat, another global risk modeler.

Most people in the business of predicting risk agree with Keogh that the changes in the environment matter less now than the changes in the “built environment” — the size, value and type of buildings being put in high-risk areas like Florida’s coastal zone and geologically unstable areas of California.
Stringent building codes would overcome much of those risks, but such things either do not exist or are not strictly enforced in many parts of the world, and even in the U.S. they are a state-by-state patchwork.

The lack of data on how homes survive disasters drove the Institute for Business and Home Safety (IBHS) to create a South Carolina wind tunnel late last to test how building codes and materials hold up under extreme duress.

“There has been research on wind damage to structures for several decades, but we as an industry hit a brick wall in not being able to do full scale testing,” said Anne Cope, the center’s director of research.

The wind tunnel has enough space to hold up to nine 2,300-square-foot homes. The center can test hurricane force winds, mixed with up to 8 inches of water per hour of simulated rain. For heavily wooded areas, the tunnel has a fire pit, where hot embers can be sucked into the wind currents, simulating how wild fires spread from house to house.

Cope said the aim, in part, is to become the building code analogue for the Insurance Institute for Highway Safety, the group whose crash videos have become ubiquitous since it was founded in 1959.

“The goal is we open some people’s eyes to construction standards,” Cope said.

Weird weather has undermined many of the industry’s assumptions. Some in the modeling business say the best they can do is give their clients scenarios to pick from based on the client’s own belief about the evolution of the climate. “The uncertainties are so large that a lot of our clients focus on the uncertainty they can handle and manage to, which is today’s risk,” said Peter Dailey, director of atmospheric science at AIR Worldwide.

Dailey’s firm, for example, offers a model of sea-surface temperatures — sea temperatures being one of the most important factors in hurricane formation — and an alternate model that assumes temperatures are warmer than usual. Warm seas are hurricane fuel, so those who believe in global warming can plan accordingly. Other modelers agree that what is changing is not the mathematics behind modeling, but the willingness of clients to accept their conclusions.

“There’s a lot of science involved and there’s a lot of uncertainty involved. To the extent the models produce credible results, people use them. To the extent the models produce results that might not be consistent with peoples’ view of risk, they might not use them,” Eqecat’s Keogh said.

But ultimately, no model, no matter how good, can really tell an insurer exactly what a storm means. “We shouldn’t kid ourselves that just capturing a better hurricane windfield gets you a better answer in terms of losses,” said Robert Muir-Wood, chief research officer of Risk Management Solutions.