As the most expensive natural disaster in U.S. history, Hurricane Katrina raised some serious questions about the capacity of today’s insurance industry – specifically, the ability to cover future catastrophes of this scale or even larger.
With some experts predicting that the 2006 hurricane season could be worse than 2005, we have to ask ourselves, would our industry be able to respond appropriately if a Category 5 hurricane scored a direct hit on Houston, Miami, New Orleans or even New York?
A repeat of the 1926 Miami Hurricane alone could cause losses of $130 billion if it occurred today; and only $65 billion would be insured. A Northeastern storm, similar to the 1938 Long Island Storm, would have an even greater economic impact.
Beyond hurricanes, what would happen if a major earthquake were to hit, not San Francisco or Los Angeles, but St. Louis, Missouri? This may seem unlikely, but it is actually a scenario which requires serious consideration. During the winter of 1811-1812, three major earthquakes shook the Mississippi Valley, the largest registering up to 8.0 on the Richter scale. Their center? Not far from present-day St. Louis – a city not known for earthquake preparedness. Today, geologists warn that this region is due for another major quake sometime before 2050. If a quake of that size occurred today in that location, where local building codes don’t reflect such risks, the results in terms of potential loss of life and property damage would redefine what we think of as “catastrophic.”
Of course beyond these and other natural events, we continue to face the man-made risks associated with terrorism. As the recent arrest of 17 suspected terrorists in Canada demonstrated, terrorism is a real threat that will be with us for the foreseeable future. And consider, the last coordinated terrorist attack we experienced was 9/11 resulting in some $40 billion to $50 billion in insured losses and much more than that in uninsured losses – financial and otherwise. For a more coordinated multi-city attack or a nuclear event, the impact on every level would be horrendous.
The concerns I raise about a Mississippi Valley earthquake and the ever-present threat of terrorism reflect my belief that we have entered what I call a “New Era of Risk.”
Think about it: Overall, eight of the 11 most expensive disasters in US history have occurred in the last five years alone, while the other three disasters on that list all took place between 1989 (Hurricane Hugo) and 1994 (the Northridge Earthquake). This reflects inflation to a degree, but to a greater extent, it reflects the sheer density of development. We are concentrating a great deal of our economic interests in what happen to be areas prone to natural disasters. Of course, as respects the threat of terrorism, the concentration itself, irrespective of weather patterns, feeds the risk. As we continue this development trend, the economic impact and far-reaching ripple effect of such events becomes more and more severe.
In the insurance business, we help clients assess their risks, prepare for any number of scenarios, mitigate their exposure – that is transfer it to another party, and, if something bad does happen, we help in the aftermath.
Today, the insurance industry needs to turn the tables on ourselves and ask if we are adequately prepared for the “next big one” – the high-impact disaster that joins these other names in terms of massive damage and destruction.
The insurance industry is stronger today than it has been in years. The industry’s aggregate policyholders’ surplus for the United States property and casualty market is currently estimated at $427 billion, an ample amount to absorb a single natural catastrophe. While in modeling, disasters only happen one-at-a-time, in real life, we have to be prepared for multiple, concurrent events which could wreak havoc not only on the insurance industry but on the entire American economy.
Consider:
- The American Academy of Actuaries modeled a medium chemical, nuclear, biological or radiological attack on New York City would result in $446.5 billion in losses. Such an event in San Francisco would inflict $92.2 billion in damage.
- The 2005 North American hurricane season resulted in over $83 billion in losses; and hurricane experts predict that the 2006 season will be just as bad if not worse than what we experienced in 2005. And a Category 3 hurricane hitting the Northeast could cause $300 billion in damages, according to the National Association of Insurance Commissioners.
- Remember the earthquake that geologists predict will hit the middle of the continental United States between now and 2050? $275 billion in economic losses and $100 billion of insured losses are assumed.
- All this in addition to the fiduciary duty the insurance industry has to pay every day claims and those claims arising out of “expected” catastrophes. So what happens if any two of these events occur more or less simultaneously?
Despite the financial health of the industry, there simply is not enough capacity in this New Era of Risk. I am not a geologist, but earthquakes seem to be more prevalent today than in recent memory. I am not a meteorologist, but all you have to do is turn on the Weather Channel to hear about this year’s hurricane season. This is why, more than ever, it is critical that the United States establish a single plan to deal with disaster insurance issues. Whether this takes the form of a National Disaster Insurance Program that resembles Pool Re in London or having carriers set aside additional surplus on their balance sheets with some tax benefit or some other mechanism – we need a program that we can all agree upon and will all live by. The laws, if you will, governing the insurance industry have remained pretty much the same but they do not reflect the reality that this new era of risk presents. It seems we have gotten very good at holding a lot of different meetings all around different size tables. What we need is a single meeting with everyone around the same table to figure out what the right vehicle is. Whatever the result, it would provide the financial resources to cover losses from catastrophic disasters – an insurer of last resort. Natural and, regrettably, man-made disasters are permanent problems to which we need a permanent solution to protect the long-term economic security of America.
Opponents of a plan–especially one that requires some federal involvement-argue that absorbing losses from catastrophic disasters is merely the price that insurance companies must pay for doing business. No question, carriers should be and are the first line of defense – but the discussion cannot stop there because it is not that simple.
When all the claims are paid out in Louisiana, every dollar of home insurance profits ever earned in the state will be wiped out. So carriers are faced with some choices and generally speaking, they go in one of two directions: drastically increasing premiums or abandoning certain categories of risk. Not taking action in one of these directions–and both are a reality in the market today–could threaten to bankrupt their business and then we would all be in worse shape.
In the area of windstorm and flood insurance, coverage for accounts renewing in the last quarter of 2006 will be severely restricted if we have an active hurricane season with substantial insured losses. Of note:
- Deductibles for commercial properties in what insurers perceive as wind-prone areas- whose geographic scope has grown-that were historically 1-2 percent of values affected in a storm are now increasing to a minimum of 5 percent of values affected in a storm, for many accounts.
- Insurers are withdrawing stop loss agreements, which are typically to a nominal level of $1 million or so, to limit insured losses in named storms.
- Rate increases of 50 – 100 percent, more in some instances, are common.
- Even worse, stricter building codes have not been universally adopted throughout Florida or in other coastal states, even in some of those undergoing reconstruction after last year’s storms.
We are also seeing similar trends when it comes to earthquake insurance: Although the length of time between the last major earthquake event and 2004 resulted in an overall softening of rates for earthquake insurance, the general issue of catastrophe perils became a renewed focus for the insurance industry.
- Western Re/Managers Insurance Services notes that since the beginning of 2006, California Earthquake rates have risen 25-35 percent.
- Two major California earthquake insurers have announced cutbacks in capacity, while a third has withdrawn from the market completely.
And natural disasters don’t just affect those in the directly-impacted area. Along with those on the Gulf Coast who have been affected by Katrina, farmers in the Midwest took a hit as increased transportation costs made their crops less competitive. In New York, consumers paid higher home heating prices as the result of last summer’s hurricanes. Out West, local officials are fighting to stop proposed cuts in funding for fighting wildlife fires to pay for reconstruction in New Orleans. These developments make clear the critical need for a national approach to absorb the increased risk of catastrophic damage.
The backstop provided by a National Disaster Insurance Program, if that is the vehicle, is not a new idea. After the massive damage caused by Hurricane Andrew in 1992 and the Northridge Earthquake in 1994, proposals were floated to create such a program. Unfortunately, parochial concerns short-circuited that effort – again, different sets of people sitting around different tables. This is a major reason why we need an Optional Federal Charter for the insurance industry. The state-by-state system is not only a burdensome administrative hurdle for us, but it complicates the insurance submissions we make on your behalf.
No doubt there are many Americans who wish we had established a plan, or had properly built the operations of the National Flood Insurance Program. I do not know any business, insurance or otherwise, that can pay out $23 billion against $2.2 billion in revenues. The program is actuarially unsound and the shortfall will continue unless we all get around that one table.
The federal government addressed the challenge of insuring against uncertain catastrophic risks, at least temporarily, with the Terrorism Risk Insurance Act and the subsequent extension. It is a good conceptual model. And at least with respect to terrorism, there is no doubt in my mind as to the need for the government’s involvement because such acts are not attacks on companies or mere property – rather they are attacks on our country.
By providing a federal backstop for insurers in case of excessive loss from terrorism, TRIA makes it possible for insurers to offer high-risk terrorism coverage with the knowledge that a single event will not bankrupt them. It also satisfies certain requirements for commercial mortgages. Moody’s generally requires terrorism coverage in order for a commercial mortgage backed security to receive the agency’s highest rating. What’s more, a recent survey of 123,000 loans by the Mortgage Bankers Association found that investors and loan servicers require terrorism insurance on 94 percent of that debt; while approximately 70 percent of Fannie Mae and Freddie Mac loans require Terrorism Insurance.
However, TRIA is set to expire in December, 2007, which means that renewals beginning on January 1, 2007 may be negatively impacted. This would have a domino-like effect throughout the economy. According to the recent study “The Economic Effects of Federal Participation in Terrorism Risk,” failure to renew TRIA past the end of 2007 could actually reduce GDP by 0.4 percent. The consequences of not having a terrorism insurance mechanism are, among other reasons, why the Real Estate Roundtable was so active in the formation of the original TRIA as well as the extension. Further, working with NAREIT, the Roundtable’s contribution in forming the Coalition to Insure Against Terrorism, with the support of so many members of Congress, underscores the need for a national solution. All this effort is now focused, of course, on moving the President’s Working Group in this very direction. Again, think about the requirements bankers and other financial institutions put on you with respect to protecting their investments. This is critical if you–the real estate industry–are going to continue operation which in turn is a vital part of our national economy.
If the global insurance industry is going to continue to provide protection for the U.S. economy, a new era of risk demands new approaches. It may not be possible to stop Mother Nature from unleashing her wrath and the risks associated with terrorist attacks are here to stay, but by working together, the insurance industry and lawmakers have the power to minimize post-disaster disruptions.
We’ve got an opportunity here and it is critical that we not only recognize it but also seize it by reforming and modernizing the regulatory structure of the insurance industry. The best way, to my mind, is by adopting an Optional Federal Charter that will finally put in place a single, coordinated, federal process to find the solution that will afford some level of economic security in the face of natural and man-made catastrophic events. It is in the best interests of our country and, in my mind, there’s truly not a moment to waste.
