Cost of Catastrophes

• Based on 51 years of statistical data through November 2001, hurricane forecaster Prof. William Gray predicts above-average hurricane activity for 2002. The likelihood of a hit to the US coastline is 86%. The average for the last century was 52%.
• Over 68 million people live in hurricane-vulnerable coastal areas of the US, a 31% increase since 1970. 55% of the US population live within 50 miles of the east or west coast.
• A major earthquake measuring 8.2 or higher in San Francisco could cause as much as $84 billion in damage.
• Since 1990, the number of tornadoes occurring in the US exceeded 1,000 annually. In the three preceding decades, only one year exceeded the 1,000-mark—1973.

The destruction of the World Trade Center has changed the concept of risk beyond all previous levels. The impact of this event, at its minimum, is more than three times that of Hurricane Andrew, which had been the costliest US disaster on record. It also affected more types of insurance than any other disaster, making both insurers and policyholders rethink future exposures.

An insurance company’s ability to underwrite insurance policies is tied to its capital and the risk of the properties it insures. With less capital available, and as much as $40 billion in insured P/C claims to cover as a result of the 9/11 attacks, insurance costs for many lines are rising. Part of the reason is because of the current reinsurance market. Reinsurers are bearing the brunt of major claims payments associated with the attack. In addition, reinsurers say they will no longer cover future terrorist acts because it’s impossible to price the risk. Some terrorist insurance coverage is available but at a substantial premium.

According to a study released in April 2002 by the Council of Insurance Agents and Brokers, the hardening of the commercial lines market is causing premium increases to continue six months after the attacks. Limits are reported to be dropping, and some lines such as construction, transportation and manufacturing are finding it difficult to get insurance at all. Risk exposures are also being sharply restricted beyond terrorism. The survey of 157 insurance companies found that for the first quarter 2002, the majority of commercial accounts saw insurance premium increases in the 10–30% range. Nearly a third of large accounts experienced a 30–50% premium hike.

Following Hurricane Andrew in 1992, insurers began to reassess the likelihood of losses using computer models to pinpoint areas prone to risk and by the type of catastrophe(s). To help them better withstand the financial strain of a mega-disaster, insurance companies now require policyholders living in natural disaster-prone regions of the country to assume a greater share of the risk through higher deductibles. With the onset of stronger building code enforcement, the availability of disaster-resistant building materials and other loss prevention measures, insurance companies are hopeful that future catastrophic losses can be reduced.

A catastrophe, in insurance terms, is an event that causes more than $25 million in insured property damage and affects multiple insurers. Catastrophes can be natural disasters such as tornadoes or floods, as well as man-made ones such as the 9/11 attacks.

2001 US catastrophe results

US insured catastrophe losses for 2001 are estimated at $24 billion (as of March 2002), as compared to year-end figures of $4.3 billion in 2000 and $8.3 billion in 1999. Although the number of catastrophic events were at the lowest point since 1969, 2001 insured loss totals are the highest in history. Property loss totals for the World Trade Center attack are not finalized.

As indicated in the chart “2001 Major US Catastrophes,” there were a total of 20 catastrophes for the year. There were 24 catastrophes reported in 2000, 27 in 1999, 37 in 1998 and 25 separate events reported in 1997.

According to Property Claim Services (PCS), 1.5 million catastrophe-related claims were filed in 2001 (as of 3/02), compared to 1.4 million in 2000. 1999 had the third highest number of claims reported for a single year with 3.3 million. It was exceeded only by 1996 when 3.9 million claims were filed and 1998 with 3.5 million claims.

2001 Ohio catastrophe results

Ohio was spared of any sizeable natural disaster during 2001. Click here for Ohio’s catastrophe record. PCS estimates the Buckeye state’s 2001 insured catastrophes totaled about $35 million.

Of note is a possible discrepancy in Ohio’s insured catastrophe losses for 2001. A rare, but costly hailstorm in the Dayton-Kettering area on April 9, 2001 caused at least $70 million in insured losses, according to an Ohio Insurance Institute (OII) survey of its members. Losses from the golf ball-sized hail that reigned over the Dayton suburb for several minutes resulted in insurance losses exceeding the $45 million of damage caused by the September 20, 2000 Xenia tornado. The OII survey found that at least 27,600 claims were filed from the hailstorm.

Ohio’s 2000 insured losses totaled $102 million for six events. 1999 insured losses totaled $375 million, with over 135,000 claims filed. Ohio’s 1998 insured losses totaled $165 million and $130 million in 1997.

Deductibles and availability in disaster-prone areas

Insurers in 17 catastrophe-vulnerable states may now use percentage deductibles on homeowners insurance policies rather than a dollar deductible. Percentage deductibles for windstorm and hail losses vary from 1–5% of the home’s insured value. This program varies by state and insurer, and the deductible may only apply on a regional basis. Some companies provide supplemental policies to cover the deductible, while others also provide a dollar-amount deductible policy at a higher premium.

Insurance companies writing business in California must offer earthquake insurance to their homeowner insurance policyholders. The policy can either be underwritten by the California Earthquake Authority, if the insurer is a participant in the pool, or through the company itself. At year-end 2000, only 17% of California’s homeowners were insured against earthquakes.

To address disaster-prone areas of Texas and insurance availability problems, insurance companies can offer deductibles up to 5% of the home’s insured value for claims associated with wind, hurricanes and wind-driven rain.

Paying for catastrophes

The price of an insurance policy reflects the costs of paying claims covered by that policy, as well as an insurance company’s costs. Insurers buy reinsurance to protect their assets, just as individuals and businesses buy insurance to protect theirs. Reinsurance is sold in layers, reaching into the millions—even billions—to protect insurers from the possibility of a devastating disaster.

1992’s Hurricane Andrew initially raised the bar as far as how devastating a mega-catastrophe can be. The attacks of September 11 raised it even further. Reinsurance companies have seen risks grow dramatically beyond the $8 billion pre-Andrew estimates.

Terrorism coverage is no longer offered as a standard coverage to commercial policyholders as a result of the September 11 attacks. With a shortage of catastrophe reinsurance, especially for large national insurance companies, some insurers are turning to capital markets to cover claims at higher levels once reinsurance has been exhausted.

The future of catastrophe protection

At close of publishing Congress was working on legislation that would make the federal government the reinsurer of last resort for major terrorist attacks. As of January 2002 the two houses of Congress had not agreed on a plan.

Such catastrophe programs exist in other countries. New Zealand, Japan, France, and the Netherlands have such programs in place. New Zealand’s, funded from a levy place on all fire insurance policies, covers damages caused by earthquakes, floods, tsunamis, landslides, volcanic eruptions and hydrothermal activity.

Great Britain has a program that provides terrorist insurance coverage. The government formed a mutual reinsurance pool for such coverage in 1993 following acts of terrorism by the Irish Republican Army. Insurance companies that are members of the pool sell coverage to policyholders at rates set by Pool Re, which vary according to which of four zones the property is located.

Spain also has a government-sponsored reinsurance pool which covers both terrorist acts and natural disasters such as floods, but not business interruption coverage. Private insurers may offer coverage but are still required to make payments to the pool. Property rates are established by the pool.

Sources: Property Claim Services (PCS), a unit of the Insurance Services Office, Inc. Excerpts from “Insurance Issues Update,” Insurance Information Institute, Ruth Gastel, editor

Ohio has had more than 120 mostly minor earthquakes in the past 200 years. (Ohio Seismic Network)

Source: Property Claim Services, a unit of Insurance Services Offices, Inc., as of 5/02

Note: This chart only includes the most severe catastrophes. Quarterly estimate totals include additional events as noted.

More than 50% of the Fortune 1000 companies might not be well prepared to recover from a major disruption to their top earnings driver, and less than 25% might have adequate contingency plans. These are the findings of the Protecting Value survey conducted by FM Global, a commercial property insurer. Nearly 200 CFOs, treasurers and risk managers participated in the study.

Sources: Property and business interruption insurance estimates from New York Department of Insurance as of 3/26/02, remainder of loss estimates from Swiss Re as of 3/13/02

Source: Insurance Services Office, Inc., as of 3/02

Source: Insurance Services Office, Inc.

3 of the 10 costliest US catastrophes on record occurred in 2001 with estimated insured P/C losses as of March 2002 totaling $21 billion.

Source: Munich Re, as of 12/28/01

Sources: US Geological Survey, FEMA, Uniform Building Codes, Council of State Governments

There were about 700 natural catastrophes worldwide in 2001, well below the record-setting previous year when 850 were reported. Insured losses were 53% higher in 2001 than the $7.5 billion in insured worldwide losses reported in 2000. (Munich Re)