• According to Property Claim Services (PCS) unit of the Insurance Services Office, Inc., the F5 tornado that cut a destructive path through Oklahoma City and surrounding towns, and the related tornadoes and high winds in 18 states occurring May 3-7, 1999, caused an estimated $1.5 billion in insured losses, a US record for a tornado-related catastrophe. Total claims were expected to exceed 370,000.
• As of early December, 1999, insured worldwide catastrophic event losses for the year totaled $22.2 billion.
• The Home Insurance Federation of America reported in a USA Today editorial (9/7/99) that estimated costs of potential disasters-from hurricanes and earthquakes-could render the following amounts of damages (in billions of dollars) to these areas:
  • San Francisco: $85
  • Memphis: $70
  • Miami: $53
  • NY/NJ: $52
  • Seattle: $17

The enormous potential for future losses is causing the P/C insurance industry to rethink its strategy regarding insurance products. Prior to 1992's Hurricane Andrew, many experts thought the worst possible windstorm could cause no more than $8 billion in insured property damage. Andrew's estimated price tag of more than $15.5 billion was nearly twice that prediction.

A catastrophe, in insurance terms, is an event that causes more than $25 million in insured property damage and affects multiple insurers. This new threshold became effective January 1, 1997, being raised from the previous threshold of $5 million. Catastrophes can be natural disasters such as 1999's Hurricane Floyd, as well as manmade ones such as the Oklahoma City bombing in April, 1995.

US insured catastrophe losses for 1999 totaled over $8.16 billion (as of February, 2000), as compared to year-end figures of $10.07 billion in 1998 and $2.6 billion in 1997. 1999 totals make it the fifth worst year for US P/C insurers since 1949, when catastrophe record-keeping began. This compares to $7.4 billion in 1996, $8.3 billion in catastrophe losses in 1995, $17 billion in 1994, $5.6 billion in 1993 and the record $23 billion in 1992, which included Hurricanes Andrew and Iniki.

As indicated in the chart "1999 Major US Catastrophes" (click here), there were a total of 27 catastrophes for the year. There were 37 catastrophes reported in 1998, 25 in 1997, and 41 separate events reported in 1996.

According to PCS, 1999's 3.3 million catastrophe-related claims are the third highest reported for a single year. It is exceeded only by 1996 when 3.9 million claims were filed and 1998, with 3.5 million claims. The costliest 1999 catastrophe was the $1.96 billion loss to victims of Hurricane Floyd, affecting at least 16 states in mid-September. As of February, 2000, it ranked as the sixth costliest insured catastrophe in the US. Other billion-dollar events in 1999 included a series of January tornadoes and winter storms affecting 30 states at a cost of $1.8 billion and the series of early May tornadoes, winds and hail affecting 18 states at a cost of nearly $1.5 billion.

Insurers in more than a dozen catastrophe-vulnerable states are using percentage deductibles on homeowners insurance policies rather than a dollar deductible. With insured losses from weather-related disasters growing in certain parts of the country, insurers have found it increasingly difficult to find reinsurance products to protect their bottom line without reducing their potential to maximum losses from such events. Higher deductibles are helping to address this situation.

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 the dollar-amount deductible policy at a higher premium.

Some insurers are limiting insurance business in windstorm-prone areas of the East and Gulf Coast to reduce maximum loss exposures.

Hail storms can also cause catastrophic losses. In Colorado, insurers have increased deductibles for wind and hail. This is also true for hail-prone states including parts of Texas, Kansas and Kentucky.

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 insurance to protect their assets, just as individuals and businesses buy insurance to protect theirs. This is known as reinsurance.

Reinsurance is sold in layers, reaching into the millions to protect insurers from the possibility (although highly unlikely) of a costly event such as a major class-action lawsuit or devastating disaster. Reinsurance exists to insure such large, infrequent losses.

1992's Hurricane Andrew raised the bar as far as how devastating a mega-catastrophe can be. Reinsurance companies have seen the potential for such losses grow well above the $8 billion pre-Andrew estimates.

In working with today's tighter reinsurance market, primary insurers had to adjust their strategies. Insurers now retain a greater part of the risk and they've increased their participation or share of losses in each layer above the retention. Also, as previously noted, insurers began imposing higher deductibles on claims and have made premium adjustments on a regional basis. With a shortage of catastrophe reinsurance, especially for large national insurance companies, some insurers are turning to capital markets to spread their risks, reduce costs and increase capacity. One method is through "act of God" bonds. This type of bond generally pays a high interest rate and is structured so that a major disaster triggers some change in the underlying agreement. In some cases, the investor may lose some or all of the bond principal and interest payments. With others, partial interest or principal is at risk. Another investment vehicle outside of reinsurance is the development of bond packages, where proceeds are invested in US Treasury securities for collateral. Although the number of transactions involving the capital markets so far has been small, some industry observers expect a robust market for these types of securities to develop in the next 10 years or so.

Premiums reflect the normal level of expected catastrophes in a given community, such as windstorms, tornadoes or fires. Flood losses are covered by a separate policy, while earthquake coverage is usually provided by an endorsement to homeowners or renters insurance policies. So how do insurers deal with extraordinary losses?

Prior to Hurricane Andrew, insurance companies accounted for catastrophes with a special premium amount known as "catastrophe loading." Using data spanning 30-40 years, to spread the cost of catastrophes over a long period of time, and sometimes using data from several states subject to the same kind of catastrophes, insurers developed the average annual cost of catastrophes. In pre-Andrew times, catastrophe loading for Florida homeowners averaged $50, 14% of their $366 average premium.

Today, more sophisticated computer modeling techniques are used. Many insurers now base premiums on meteorological data combined with their own exposure data. Meteorological data shows the probability of a natural disaster occurring in a specific area, and the exposure data indicates how many of the company's policyholders are likely to be affected and to what extent. The combination of these factors help in estimating what the insurer's potential losses from an event are likely to be.

In the US, special pools known as Beach and Windstorm Plans help ensure the availability of windstorm insurance for properties close to the ocean. These are funded by the property insurers writing insurance and exist in seven Gulf and Atlantic coastal states.

The Homeowners Insurance Availability Act of 1999, HR 21, is a composite of two previous legislative proposals. Under the bill the federal government would reinsure state-run residential property insurance pools and private insurers through one-year excess-of-loss contracts that would be bought at auction from the US Treasury. The decision as to when federal reinsurance would kick in will be made by the Secretary of the Treasury.

Increasingly, the emphasis is on damage mitigation efforts. The insurance industry has formed a new organization, the Insurance Building Code Coalition, to push for a standardized national building code and compliance system. Currently there is no uniformity, with some states lacking statewide building codes. Some communities also have separate building standards.

In Florida, homebuilders have tried to roll back South Florida's strong building codes. The Florida Building Commission has given tentative approval to a new uniform building code that would require storm shutters or impact-resistant glass on all new coastal area construction. Although basic storm shutters add $3,000-$5,000 to the cost of a typical new home, the homeowners insurance discount of 14% helps to offset the cost. The new proposal also upgrades roofing standards and bans the use of staples to secure roofing materials.

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

Three of the four deadliest earthquakes in the 1900s occurred in the 1920s. The top 4 were:

• 1976 in China 8.0 magnitude 255,000 deaths
• 1920 in China 8.6 magnitude 200,000 deaths
• 1927 in China 8.3 magnitude 200,000 deaths
• 1923 in Japan 8.3 magnitude 143,000 deaths

(US Geological Survey, reprinted from USA Today, 8/18/99)