Industry P&C the October 2011 issue

A Mighty Wind

The new RMS U.S. hurricane model has carriers and brokers worried about what it will mean at renewal time.

As impressive as Katrina was, it was not the mightiest storm to hit American shores. That honor goes to the 1935 Labor Day hurricane that pounded the Florida Keys with winds approaching 200 mph. Yet with one exception, Hurricane Hugo in 1989, the costliest storms in terms of economic and insured losses have occurred in the last 20 years.

Considering that 2011 already holds the title of highest loss year for global catastrophes on record—with $265 billion in economic losses, mostly from the Japan earthquake—a bad hurricane season could be the tipping point for insurers’ profitability.

The p-c industry has been lucky over the last few years, but luck may be running out. We’re in the middle of an above-normal Atlantic hurricane cycle, which began in 1995. These cycles, known as the “tropical multi-decadal signal,” can last 20 to 30 years or more and alternate between above-normal and below-normal seasons. 

At the same time, land and ocean temperatures are warming, according to the National Oceanic and Atmospheric Administration (NOAA). The power of hurricanes has increased since the mid-1970s, NOAA says, when the most rapid increase in global ocean and land temperatures began. Still other scientists say a bigger factor in Category 3 to 5 storms is the difference in temperature between the Pacific and Atlantic oceans.

Whatever the factors, the losses are mounting, making the release of an updated hurricane model even more timely. Earlier this year Risk Management Solutions (RMS) introduced version 11 (RMS11) of its U.S. Hurricane Model. RMS periodically updates its models as more data become available, and the company says that “10 times more data” was available for RMS11 than for the last version. RMS11 includes data on wind hazards, the ability of buildings to withstand wind, wind and storm surge models, roof durability, and lessons learned from low winds but large storm surge events.

Michael Kistler, director of the Natural Catastrophes and Portfolio Solution, says the new RMS model provides “state-of-the-art, non-biased, best-in-class data available to help clients understand their risk exposure.” The model harnesses the latest in computing power. The company says it ran thousands of storm simulations to “generate the most detailed modeling study ever designed to understand the way hurricanes decay over land.” The update also underwent rigorous review by peers in the academic community and the Florida Commission on Hurricane Loss Projection Methodology.

The concern is how the new modeling will affect exposure risks. Wind risk losses are expected to increase nationwide but will vary by region and line of business. The smallest change will be along coastal areas. Commercial business will show the greatest increases, but some portfolios may see a decrease. Changes in Florida, for example, may be less than in Texas, Alabama, Mississippi and Louisiana, where significant loss increases are expected.

One reason for this may be tougher building codes and better performance in Florida for coastal residential properties. In contrast, buildings in Texas haven’t fared as well. Whether because of construction or the elements, the loss difference is measurable.

How much of a change are we talking about? Marsh estimates the loss changes may range from plus 20% to plus 100%. The extreme range, depending on exposure factors, could range from minus 50% to plus 300%. Texas and the Gulf could see changes between plus 50% and plus 150%. RMS also projects significant increases in damages for the Mid-Atlantic region, where storms coming inland, such as Hurricane Irene in August, are weakening at a slower pace.

Modeling offers valuable tools for the insurance industry. It helps insurers and clients understand their vulnerability to risks, and it helps them manage those risks. But the RMS11 model is not without controversy, and insurers were initially cautious about adopting it. Some carriers say it will change their exposure; others say it won’t. But acceptance is growing. Kistler says they have a 90% adoption rate for the wind and storm surge models among their client base—primary carriers, reinsurers and brokers.

The other elephant in the room, of course, is its impact on pricing. If insurers and reinsurers see more exposure in their portfolios, will they raise prices to reflect the new risks? The jury’s still out, but The Council’s second-quarter commercial p-c pricing survey indicates that RMS11 was a small factor in commercial property pricing in some regions. The true test of the model’s impact will be felt at January renewals, and that will depend on carriers’ appetite for risk and pain, available capacity and the severity of the hurricane season.

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