Property/Casualty Insurers Applying Lessons Learned From Hurricane Katrina

New Orleans, LA – The property/casualty insurance industry is employing advancements in catastrophe modeling and considering the impact of the creation of a national catastrophe fund as it applies lessons learned from Hurricane Katrina, attendees at the Casualty Actuarial Society’s Spring Meeting were told.  Experts on a panel moderated by Louisiana Insurance Commissioner Jim Donelon discussed the post-catastrophe landscape in the city that was dramatically changed by 2005’s Katrina.

John Rollins, vice president of AIR Worldwide Corporation, outlined what catastrophe modeling firms and the property and casualty insurance industry have learned about the scientific and actuarial nature of hurricane risk since Katrina.
Rollins said the current state of the science on climate change projects potentially less frequent, but more severe tropical cyclones.  He added that research on the impact of climate anomalies on hurricanes has influenced modeling advances. 
“The research of AIR and other modeling companies has tried to capitalize on climate science and adapt it into the parameters of the catastrophe models,” Rollins said.

In validating the models, the 2004/2005 hurricanes provided unprecedented quantities of detailed claims data, Rollins told meeting attendees.  He said that modeling firms review actual insurer storm claims data against modeled damage for the same locations and examine results by coverage, construction, and occupancy type.  For example, damage to pool enclosures, which are common in Florida and can cost between $10,000 to $50,000, accounted for about 15-20 percent of losses from these hurricanes.  The average claim per unit of exposure was reported to be as much as 35 percent higher for homes with pool enclosures.  “We have to get a handle on what to charge for that because it’s the type of thing that might fly under the radar of a catastrophe modeler and the industry until after an event,” Rollins said.

Modelers are also in a unique position to help companies address exposure data challenges, he emphasized.  They can do this by delivering commercial and residential property specific data, including replacement value, and enhancing the capture and use of quality exposure data at the point of underwriting.

The managing director for public finance at Raymond James & Associates, Inc., John Forney, praised the leadership of Commissioner Donelon in Louisiana and said the market has even gotten stronger in the state under the policies the commissioner has implemented and the management team he hired at the state-run property insurer of last resort, Louisiana Citizens Property Insurance Corporation (LCPIC).

“The provision of insurance for natural catastrophes is not a science that is cast in stone,” Forney stated.  “It occurs at the intersection of insurance, finance, economics and public policy and there isn’t a huge realm of data that enables an actuary to pinpoint exactly how this whole business works and how it should work from both the financial and actuarial standpoint, as well as from a public policy standpoint,” he said.

The Raymond James official listed some of the major catastrophes in the U.S. since Hurricane Andrew in 1992 caused $15.5 billion in insured losses in South Florida and pointed out that 7 of the 10 most costly catastrophes have occurred since 2004.

Forney said lessons learned include the extreme difficulty of insuring losses from natural catastrophes.  “Some might say they’re impossible to insure,” he warned, “they violate some of the fundamental standard conditions of insurability because they’re infrequent, they’re catastrophic, they unpredictable, and the losses are interdependent.” He said that these factors had resulted in an increasing trend toward government involvement in catastrophe insurance and reinsurance.  He listed the creation of the Florida Hurricane Catastrophe Fund in 1993, the California Earthquake Authority in 1996, the Terrorism Risk Insurance Act in 2002, and the creation of state-run insurers in Florida (2002) and Louisiana (2003) as examples.

Commissioner Donelon said the creation of Louisiana Citizens Property Insurance Corporation has worked exactly as it was designed and has put the state in a better position than other states with similar programs – Florida and Texas.  “Those states, though, like Louisiana, are working to solve their problems but are also looking to the federal government to create a responsible safety net similar to TRIA to provide financial assistance, if needed,” the commissioner added.

Addressing the hurricane peril in Louisiana in the post-Katrina landscape from a public policy standpoint, David Chernick, a consulting actuary for Milliman, Inc., examined the capacity, availability, and affordability of residential property insurance in the state. 

“Since Katrina hit, the size and number of policies in the residual market (LCPIC) is about the same and so obviously the work of the (insurance) commissioner has paid off in keeping the policy count down,” he said.  But the size of the exposure has doubled from $14.9 billion in December 2005 to $27 billion in April of this year, “and I think this is a phenomenon we’re going to see everywhere because the cost of rebuilding houses is going to go up every year.”

Chernick provided an overview of the Homeowners Defense Act of 2009, draft legislation that would create a national catastrophe fund, which among its provisions would offer catastrophe reinsurance to state catastrophe plans; encourage states to create state catastrophe funds; offer liquidity and catastrophic loans to state plans; and provide funding for mitigation and preparedness.

Applying the basic structure of a national and state catastrophe fund system to what is in place currently in Louisiana, Chernick showed that for a one-in-a-thousand year event causing $16 billion in insured losses, primary insurers would pay out $6.9 billion, a Louisiana State Cat Fund would be responsible for $4.7 billion, a National Cat Fund would pick up $3.2 billion, and Louisiana Citizens would take care of the remaining $1.2 billion. In contrast, under the current system primary insurers would pay out an estimated $9.5 billion, $4.1 billion would be from reinsurance/catastrophe bonds, and the remaining $2.4 billion would fall to the state-run LCPIC.

A national/state cat fund system would result in an average statewide savings in Louisiana of about 28 cents out of every dollar of homeowner insurance premium, he said.

The CAS Spring Meeting was held May 3-6, 2009.  The CAS fulfills its mission to advance actuarial science through a focus on research and education, with 5,000 members who are experts in property-casualty insurance, reinsurance, finance, and risk management.