Swiss Re: 2011 Earthquakes Highlight Industry ‘Blind Spots’

The devastating earthquakes of 2010 and 2011 highlighted some blind spots in the industry's underwriting and catastrophe modeling, Swiss Re said.

"Looking back at the last two years, we've learned a number of lessons, but we feel the industry has been slow in digesting these lessons," Balz Grollimund, head of earthquake, property and specialty for Swiss Re, said.

One "blind spot" was the damage caused by the tsunami that followed the March 11, 2011 quake in Northern Japan, he said.

"In hindsight it should not have come as a surprise that a tsunami could cause this loss, but we as an industry don't really model for tsunamis in earthquake in a systematic way," Grollimund said.

Swiss Re, which has its own catastrophe model, has now built a tsunami model for Japan and is looking to expand it to other countries including Chile, Peru, Ecuador, Mexico, Central America, and the Western United States.

"We consider risks on a case-by-case basis, but have already changed the approach to reflect tsunami risks in these regions," Grollimund said.

Another blind spot for insurers was the damage caused by aftershocks, which can be bigger than the original quake, he said.

"Risk models are calibrated on long-term averaged seismic activity, and are out of their comfort zone when it comes to months and sometimes years following large events when earthquake activity is substantially increased. It's not what the models are built for," Grollimund said.

Models are a "simplification of reality," he said. "Underwriters can put too much trust and weight on the models. Sometimes it is helpful to take a step back and look at the bigger picture."

Swiss Re has adjusted its underwriting in zones where it sees increased aftershock activity, especially in Japan and New Zealand, he said.

"We haven't pulled back. As long as we get the right premiums to compensate for the risk we take, we are available to offer earthquake reinsurance," Grollimund said.

The major quakes in Chile, New Zealand and Japan also highlighted the importance of losses from secondary factors, including soil liquefaction, business interruption and contingent business interruption.

"These agents contribute significantly to the overall insurance costs of events, yet they have been traditionally undervalued in loss modeling," according to "Lessons from Recent Major Earthquakes," a study by Swiss Re.

Business interruption claims amounted to about half of the total insurance payout to industrial facilities in Chile following the February 2010 quake. In the pulp and paper industries, business interruption claims were two-thirds of the total payout, Swiss Re said.

Total insured earthquake claims for 2011 were $47 billion, the highest ever for the industry. Grollimund, one of the authors of the study, said the record losses came even as earthquake insurance penetration for most areas is low.

The exception is New Zealand, where earthquake insurance is mandatory. The February 2011 quake there caused $15 billion in economic losses and $12 billion in insured losses, so 80% of the losses were covered by insurance.

Compare that to the up to $300 billion economic losses from the Japan quake. While the quake resulted in $35 billion in insured losses — an industry record — only 17% of the total losses were covered by insurance.

The insurance industry needs to raise the awareness of the need to buy earthquake insurance, he said.

"One of the steps the insurance industry could take is to do a better job in explaining policyholders why earthquake insurance is important. This would help to increase the take-up rate," Grollimund said.

Earthquakes were the biggest drive of catastrophe losses in 2011, said Thomas Holzheu, Swiss Re's chief economist for North America, said in December (Best's News Service, Dec. 15, 2011).

Swiss Re currently has a Best's Financial Strength Rating of A+ (Superior).

(By Meg Green, senior associate editor, BestWeek: Meg.Green@ambest.com)