The absence of a major catastrophic event in Florida in recentyears has not erased memories of the 2004 and 2005 hurricaneseasons and the impact of the ensuing hard property insurancemarket. Smart Florida business owners know they cannot afford toleave themselves exposed during what could be a very busy hurricaneseason. The loss of a key facility can ruin a business.

Even with this knowledge, commercial property owners can be in avulnerable position when it comes to buying property insurance.With some lenders requiring full property coverage, no matter theprice, some businesses buy too much property coverage, others toolittle. Is it possible to calibrate coverage more precisely?

Yes, with catastrophe risk modeling. Cat models can help Floridacommercial insureds better understand their exposure to windstormrisk across their entire property schedule and down to eachindividual location. Using this sophisticated insight, insureds candetermine the proper amount of insurance coverage to match theirexposure, their financial needs, and their risk appetite.

Perhaps just as important, the modeling output can help convinceunderwriters to provide the coverage at reduced rates.

It's All About Quality

Property underwriters have used sophisticated software tools formodeling since the 1990s, and cat models have becomeinstitutionalized in the underwriting process. Today, more and moreinsurance brokers and corporate risk managers are using the models,as well. But for commercial insureds to really determine theirexposure and the appropriate level of risk to retain and transfer,the focus must be on the quality of the data that is being put intothe models.

There are many data points that can make a significantdifference in the accuracy of modeling outputs, including address,occupancy type, year built, number of stories, construction type,and secondary characteristics. However, one of the most basic andessential data points — replacement value — is often the one notrepresented accurately, resulting in property coverage that iseither too high or too low.

Why? A typical commercial insured might not have all of thisdata available for all of his properties. Or if he has some of thisinformation, it might not be accurate. It is worth taking the timeto assemble accurate data because there is a direct correlationbetween property values and modeling output, said Bill Churney,vice president of business development at Boston-based modelingfirm AIR Worldwide.

“If business owners are using bad data when buying insurance,then they are likely to make a bad decision,” Churney said. “Ifproperty values are off 20 percent, then loss estimates will atleast be off 20 percent, as well.”

In certain instances, more accurate replacement values may meanhigher values and possibly higher premiums. Even if this is thecase, it is far better to pay more to properly protect yourproperty than to experience a total loss and then discover that youdo not have enough coverage to rebuild.

Collecting detailed, accurate information on properties andentering it into the models, however, can often lead to lowerproperty premiums. To understand how this works, you have to digdeeper into modeling.

Models default to a local composite of a general geographic areaand type of construction that is prevalent for that occupancy type.Often, the model users (for instance, underwriters) may default thesettings to the most conservative or worst-case scenarios. When itcomes to property addresses, for example, these defaults help themodels determine distance from the coast and elevation, bothessential variables for underwriters.

The Human Element

Small commercial property owners and large companies — eventhose that have the internal staff and resources to collect theneeded data — can benefit by utilizing engineering resources.Engineering and risk management specialists should always have ahand in data collection and review to help ensure that the data iscomplete and accurate.

In fact, the data-collection process is even more important forcomplex properties like manufacturing sites or chemical refineries,or high-value assets that drive a portfolio's overall exposure. Notonly can specialists help insureds collect detailed data requiredto properly represent these facilities in models, but they also canhelp companies learn how to mitigate their cat risk throughretrofitting buildings or reinforcing windows and other structuralelements.

Using engineering specialists can also bridge the credibilitygap for commercial insureds with underwriters and lenders.Engineers collect and validate data, giving underwriters confidencethat the data accurately demonstrates a property's performance. Bypopulating the model with quality data, property insureds speak theunderwriters' language and show that their property schedule is abetter risk than others, that the risk has less uncertainty and, inthe case of insureds who have applied engineering and loss-controlservices, that the insured has mitigated its losses.

Bridging the credibility gap with lenders can mean that lessinsurance needs to be purchased. Generally, for windstorm coverage,lenders require businesses to purchase limits for the fullreplacement values of their properties. But a detailed, verifiedmodeling report could convince lenders to allow insureds to retainan amount of risk and purchase levels of coverage that are morecost-effective for the insureds but still adequate for the lenders'interests.

For commercial insureds who do not have their insurance levelsdictated by loan covenants, the use of accurate data in modelingcan also help determine the appropriate levels of coverage. Forexample, it is usually recommended to buy up to a 250-year to500-year probable maximum loss (the probability of a loss in anygiven year is one in 250 or one in 500). However, after an insuredreviews a modeling report with his broker, it might be determinedthat because of the concentration of properties in high-risklocations it would be more appropriate to purchase at a higherreturn period. They may also decide to purchase at a higher returnperiod if many of the properties in high-risk locations are nothardened against windstorm or surge.

Ultimately, though, it is up to the corporate risk manager orcommercial property owner to base the insurance purchasing decisionon a company's overall risk tolerance, the cost of insurance, andthe company's responsibilities to lenders, investors, and otherstakeholders. With the proper and accurate use of modeling, thatdecision can be more fully informed and result in the right amountof coverage.

Ravi Singhvi is vice president of catastropherisk modeling at NAPCO, a wholesale broker of commercial propertyinsurance coverage. www.NAPCOLLC.com.