Catastrophe modeler Risk Management Solutions surprised the industry last February with the release of Version 11 of its Atlantic Hurricane Model. Unlike RMS’s previous versions—and the models of other data crunchers like AIR and Eqecat—Version 11 posited a greater likelihood of a hurricane causing damage in inland regions well beyond coastlines.
The impetus for the upgrade, in part, was Hurricane Ike three years ago, an anomalous windstorm that wended its devastating way through the country’s heartland (see sidebar). RMS posited that other windstorms like Hurricane Ike and those spinning off tornadoes were more likely than previously believed. “Ike certainly told us we needed to make adjustments, and it gave us the data to do just that,” explains Ryan Ogaard, senior vice president of product management at Newark, Calif.-based RMS, Inc. “Were we to have another Ike, Version 11 would be much closer to reality than Version 10.”
Many property-casualty insurers were initially reluctant to give too much weight to the new version in their own catastrophe models and other calculations on the geographic accumulation of property exposures. Then, along came Hurricane Irene, which served to validate the prudence of Version 11. Although the two storms were very different from a damage standpoint—Irene caused more flooding than windstorm losses—their paths and durations were atypical.
While it is still too early to gauge the full import of Version 11 on insurers’ underwriting, rates and willingness to assume property risk in certain geographies, independent agents in regions that heretofore had little problem finding available and/or adequately-priced homeowners and business premises insurance are discovering a new reality. “We’re hearing from carriers to brace for double digit and even triple digit increases, not just for properties along the central-east-coast of Florida [where the agency is located], but zip codes that are much more inland,” says Jeff Schlitt, vice president of Schlitt Insurance Services Inc., a Vero Beach, Fla.-based independent agency.
“We have a client with several buildings inland, and the markets just shut down for one of them,” he adds. “A month ago, we would have had plenty of options for him, but now I’m limited. We can still help him, but as this model trickles down from reinsurers to carriers, it’s going to get tougher and tougher.”
Up north in New York, similar problems abound in regions that never had such issues before. “Fifteen years ago, if you bought a second house in Montauk on Long Island, I had 20 different carriers eager to provide insurance on a secondary home,” says Thomas J. Crowley, a partner at Maran Corporate Risk Associates, a Southampton, N.Y.-based independent agency. “Today, if the house is not big or expensive enough for a Chubb or Chartis to insure it, I have to go to the specialty markets. Every year seems to get worse.”
Pressure Intensifies
One cannot blame RMS for these dislocations in the property market—it’s just doing its job. “Our responsibility is to incorporate new information and science into our models as this information becomes readily available,” Ogaard says. “Version 11 is based on fundamentally new research conducted over the last three years.”
There is science behind the upgrade—the risk modeler engaged several top independent hurricane climatologists and engineers to help develop and rigorously review the new model. “Key methodologies and datasets included in the model—for example, around inland filling of hurricanes—have been published in peer-reviewed scientific literature,” RMS states in its introduction to the upgrade.
Whether a new model increases or decreases an insurer’s estimation of risk is beyond its control, Ogaard maintains. Nevertheless, the impact of the model can be substantial. “Models have a significant effect on reinsurers, insurers and rating agencies,” says Stuart Powell, vice president of insurance operations and technical affairs at the Independent Insurance Agents of North Carolina. “I sometimes wonder if they rely too heavily on the models, which are subject to undershooting the level of risk—the case with RMS’ [Version 10] model before Hurricane Ike. Now the new model takes this into account and the market becomes overly concerned about the loss potential.”
He adds, only half-jokingly, “Everyone knows models are wrong; we just don’t know which side of wrong they are.”
Armed with the model, one of many tools used by reinsurers and insurers to calculate risk, underwriters review their accumulated property exposures by zip code and even by building. They then determine if this is too much of a good thing. “RMS is one input, but it is a very important input,” says Clint Harris, director of property-casualty research and publications at risk management consultancy Conning. “It appears to be impacting certain areas of the country more than others. I’ve heard from RMS and some insurers that Texas, for instance, was hit pretty hard by the new version, as was the mid-Atlantic region.”
Harris adds, “Assuming insurers are using RMS exclusively or otherwise incorporating
the model into their own estimates, in most cases it increases the estimated loss, putting insurers at greater risk. And with greater risk, they will want to limit that by reducing their exposures in those areas or acquiring additional reinsurance. In either case you’re looking at higher rates following.”
Pressure on carriers to pursue these actions comes in large part from rating agencies like A.M. Best and Standard & Poor’s. If a carrier is perceived to have less capital than what is considered to be prudent to underwrite a concentration of property risks, it is threatened with a downgrade by the agencies.
Carriers generally don’t want to expose more than 20% of their capital to a single property catastrophe loss event. If a one-in-250-year weather occurrence under RMS Version 10 was estimated to cost a carrier $100 million in insured losses, and this carrier has $500 million in capital, it has reached the threshold of tolerance, i.e., exposed 20% of its capital. Now Version 11 comes along. The potential property catastrophe loss is suddenly pegged at, say, $150 million, instead of $100 million. The capital required to support the estimated exposure has increased by 50%, requiring one of two business decisions—raise additional capital or reduce the aggregated geographic risk.
If a carrier fails to make either decision, the risk of a downgrade by A.M. Best or another rating agency swells—hence the current angst in the marketplace.
Say the same carrier confronting the 50% hike in estimated loss makes decision number two and reduces its aggregate exposures. The consequence of this choice is not so great, either—a commensurate decline in written premiums. If it holds onto the business and raises its rates, and in this season of difficult treaty reinsurance renewals due to capacity constraints following the Japan earthquake and other catastrophic losses, insurers will likely kick prices higher anyway. Still, this doesn’t guarantee the top line will not erode, especially if regulators intervene and prohibit the action.
Now if the same carrier opts for decision number one and allocates more capital to a geographic book of business deemed under RMS Version 11 to be problematical from an exposure standpoint, then that capital must come from other insured risks that may, in the end, offer wider profit margins. The decisions can become very difficult, very quickly.
Aside from the rating agencies, regulators also cause upheaval, particularly those who are elected by constituents who may be direly affected by insurer underwriting decisions. “After Hurricane Andrew in 1992, insurers [in Florida] recognized they had too much geographic concentrations of risk in particular neighborhoods and they backed off on their writings, which was sensible,” says Thomas M. Cotton, president of Orlando, Fla.-based agency Hugh Cotton Insurance.
“If they had a million policies, they might back off to 750,000. Then, the insurance commissioner at the time intervened and declared a moratorium, telling carriers they could not non-renew a policy without the department’s approval. Insurers felt trapped, and as soon as they could exit
the state they did. I just hope the same scenario doesn’t play out again,” he says.
Cotton says he has no qualms with RMS Version 11 causing carriers to decrease their writings or raise their prices because of a scientific anticipation of a greater risk of insured loss. “The free market is nowhere stronger than it is in the insurance industry,” he explains. “There are always smaller carriers willing to take on a few policies here and there, albeit with a rate increase. My problem is when the government meddles in the market, and we end up with more and more business going to Citizens, the state insurer. I just hope what we’ve had to endure here doesn’t migrate elsewhere.”
The Fallout
Obviously, not all residents and business owners in parts of the country historically immune to hurricanes and other major windstorms like tornadoes need not fret about losing their property insurance tomorrow. But, more people than before are in a precarious state insurance-wise. “We have a couple large clients with facilities through Texas and up through New England that are Tier One catastrophe wind-exposed now,” says Walter Wilk, managing director, and the real estate practice leader in the Boston office of broker Wells Fargo Insurance Services.
“We’re being told by carriers two months before policy renewal that they have only a certain amount of capacity for wind, and these two accounts will be looking at significant premium increases,” he adds. “That doesn’t mean we can’t find another carrier, but it is rare for us to hear 65 days ahead of time to expect some bumps.”
J.C. Sparling, executive vice president of Mercator Risk Services, a New York-based excess and surplus lines insurer, agrees that RMS Version 11 has changed insurers’ risk appetite in the Lone Star State. “If you have lots of aggregations in Harris County, you have to show more capital, buy more reinsurance or shed some aggregate,” he says. “Suddenly these carriers are doing a lot of tap dancing.”
Similar footwork is happening in Virginia following Hurricane Irene. “I’m hearing that underwriters are taking a serious look now at regions more inland,” says Joe Hudgins, vice president of education and technical affairs at the Independent Insurance Agents of Virginia. “In the past, only regions east of Hampton Roads Tunnel were written tightly. Now, those further west are being scrutinized. When a model recognizes that hurricanes can spawn inland tornadoes lifting off a roof, it gets one’s attention.”
An early adopter of RMS Version 11, Lexington Insurance Company continues to underwrite property exposures in all the affected inland regions like the Mid Atlantic corridor and Texas. But, according to Erik Nikodem, senior vice president and property division executive, “In essence our ‘cost of goods sold’ has increased as a result of the model change. The amount of capital we must allocate to our portfolio to address the increased model risk has grown. Consequently, we are working with our agents, brokers and clients to discuss solutions, including less capacity, increased premiums and/or changes in deductibles and other terms.”
Other than these examples, the fallout from Version 11 is still to be felt. George Yates, president of East Hampton, N.Y.-based agency Dayton Ritz & Osborne, has spoken with several national and regional carriers, “and they all say that the impact of RMS 11 in New York does not yet appear to cause a reduction in capacity or a substantial premium increase,” Yates comments. “Most carriers are talking [an increase] in the range of 5%.”
Robert Hartwig, president and chief economist at the New York-based Insurance Information Institute, goes further. “The new version will not result in an unstable property insurance environment in the U.S.,” Hartwig maintains. “While there appears to be a rise in the number and intensity of weather-related events, only some are associated with hurricanes. The vast majority of property losses in 2009 and 2010 were not hurricanes; they had to do with high thunderstorm losses, tornadoes, hail and straight-line winds far away from the coastline. These losses combine to create greater expenses for insurers, and are incorporated using models and other probabilistic exercises into rate-making procedures.”
Still, Hartwig acknowledges that homeowners and business premises premiums have been creeping up in the last couple of years and will not slow down any time soon. But, he also raises an interesting question about weather intensity, and whether or not the country is in the midst of a new normal. “Certainly, we are seeing storms that hang together longer and create stronger winds and rains further inland than has been noticed in the past,” says Tim Reinhold, senior vice president of research and chief engineer at the Institute for Business and Home Safety. “This doesn’t mean this is a permanent change. Each storm has its own characteristics and personality. That said, many homes were built in these areas that are not up to withstanding the potential damage. There are few if any roofs in inland regions that can withstand 150-mph winds.”
Howard Kunreuther, professor of Decision Sciences at The Wharton School of the University of Pennsylvania, agrees that recent weather events indicate more susceptibility to damage and loss in inland regions, particularly from flooding. Unfortunately, many policyholders in the wake of Hurricane Irene lacked flood insurance. “I happened to be talking to the head of FEMA while Irene was striking the Northeast, and I said ‘I bet those affected in Vermont and New York didn’t have flood insurance,’” Kunreuther says. “He responded that it was worse than that—the communities hadn’t joined the government’s flood insurance program, meaning they couldn’t get flood insurance even if they wanted it.”
It’s a different story, of course, in Florida, where agents like John Pollock routinely apprise and urge consumers to buy insurance from the National Flood Insurance Program. “Down here mortgage insurers require it,” says Pollock, regional agency manager of BB&T’s insurance services in Florida.
Does the new model behoove more agents to do the same, irrespective of requirements? Says Pollock: “No one likes surprises.”
Remembering Ike
Hurricane Ike was the second costliest hurricane (after Katrina) to make landfall in the United States. It also was a storm like no other one, that literally startled climatologists who had never seen anything like it.
The hurricane began as a weather disturbance off the coast of Africa in August 2008. It moved westerly and slowly morphed into a Category 4 storm, passing over Turks and Caicos Islands, visiting Cuba, and finally making landfall in Galveston, Texas, on September 13, resulting in the largest evacuation in that state’s history.
To the astonishment of climatologists, the hurricane simply kept going, through Houston, Dallas, and then into the lower Ohio Valley and lower Great Lakes region. It continued its devastating march through Arkansas, Missouri, Mississippi, Kentucky, Pennsylvania and New York, before jumping the border into Ontario, Canada. Still, it was not finished. On September 17, it combined with other storms to produce almost eight inches of rain in Iceland. Finally, Ike petered out.
When all the losses were added up, they totaled $37.6 billion, of which an estimated $15 billion were insured. The bulk of insured losses, some $12 billion, occurred in Texas.
—R.B.
