• The number of natural catastrophes reached an all-time high, with more than 850 worldwide in 2000, according to Munich Re (see Top 10 worldwide insured losses for 2000).

• 2000’s deadliest twister, an F-4, tore an 18-mile path through Tuscaloosa killing 11. Property damage losses were not available at close of publishing.

• If an 8.0-magnitude earthquake hit the New Madrid fault center in Missouri, experts expect that the Tristate (KY, IN, OH) would see some damage to buildings, including damage to chimneys, monuments and walls. Drivers would feel the quake in their cars as well. A quake measuring 3.9 occurred in Evansville, IN on December 18, 2000.

• According to a June, 2000 report released by the Federal Emergency Management Agency (FEMA) one-fourth of the homes within 500 feet of the US shoreline could be overtaken by erosion within 60 years. This includes 16,000 buildings along the Great Lakes.

An insurance company’s ability to underwrite insurance policies is tied to its capital and the risk of the properties insured. 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, they cut back on the number of policies written in disaster-prone areas. Al-though insurance availability was initially a problem for some home owners, the market gradually caught up with the need for coverage.

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 Oklahoma City bombing in April, 1995.

2000 US catastrophe results

US insured catastrophe losses for 2000 totaled $4.3 billion (as of January 23, 2001), as compared to year-end figures of $8.3 billion in 1999 and $10.07 billion in 1998. 2000 totals make it the second lowest in terms of catastrophe losses in the last decade. This compares to $2.6 billion in 1997, $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 “2000 Major US Catastrophes”, there were a total of 24 catastrophes for the year. There were 27 catastrophes reported in 1999, 37 in 1998, 25 in 1997 and 41 separate events reported in 1996.

According to Property Claim Sevices (PCS), there were 1.4 million catastrophe-related claims filed 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.

2000 Ohio catastrophe results

Ohio had its share of natural disasters during the past year. (See chart Ohio’s 2000 catastrophe record.) PCS estimates the Buckeye state’s 2000 insured catastrophes totaled about $102 million. Ohio’s 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

As previously noted, 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 the dollar-amount deductible policy at a higher premium.

Hail storms can also cause catastrophic losses. In Colorado, insurers have increased deductibles for wind and hail. This is also true for hail-prone regions of Texas, which has the highest homeowners insurance premium based on 1997 data (the latest year available at close of publishing) at $855.

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 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.

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 deduct- ibles 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 cover claims at higher levels once reinsurance has been exhausted. 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.

State-run pools and building code measures

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.

In South Florida, which has one of the strongest building codes in the US, experts estimated that 25–40% of Hurricane Andrew’s losses were avoidable. Much of the damage was due to lax code enforcement.

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 program, each local fire department’s fire fighting capability is ranked according to such factors as water supply and the number of full-time, part-time and/or volunteer fire fighters. The building code rating system is incorporated into the homeowner premium rate structure. The building code rating system was first implemented in Florida, and North and South Carolina. By year-end 2000, every municipality will have a grade. Communities will be regraded every five years thereafter.

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

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