Filed Under:Claims, Catastrophe & Restoration

Who Pays for National Catastrophes?

Although insurance capacity for catastrophic perils is still available and affordable, some experts say last year’s huge losses already are driving up insurance costs and could shrink capacity, federal financial assistance or both.

When John Fogerty musically asked "Who’ll Stop the Rain?" 40 years ago, he was pondering the world’s disquiet. But given the economic and insured damage from natural catastrophes that deluged the U.S. and the rest of the world in 2011, the question today is relevant and literal.

Property owners would welcome a reprieve from rain—as well as wind, earthquakes, tsunamis and terrorism risks. But the next-best thing to a futuristic weather-control machine and world peace is the assurance that property owners can continue to count on commercial insurers and public funds for assistance in covering the cost of catastrophe losses.

Insurance capacity for catastrophic perils remains available for increasingly at-risk buyers. The stable catastrophe bond market continues to help insurers and reinsurers maintain their capacity, according to experts.

Related: Read the article "Guy Carpenter: Reinsurers Were Better Prepared for 2011 Cat Losses than in 2005" by Caroline McDonald.

But some property owners might fret about developments that some experts say are already driving up insurance costs and could drive down either insurance capacity, federal financial assistance or both. Those include the insurance industry’s response to its drop in profitability and policyholder surplus last year; a retooled formula for calculating the amount of federal financial assistance for public entities after national disasters, the future of terrorism insurance, and a modified catastrophe risk model that maintains insurers’ property portfolios are much more at risk than previously thought.

2011 was the most recent in a devastating string of years with heavy catastrophe losses, according to figures from Munich Reinsurance America Inc. of Princeton, N.J. Although there were 20 percent fewer catastrophic events than the record 1,025 in 2007, worldwide losses from catastrophes last year beat the records set in 2005, when Hurricane Katrina swamped New Orleans. Worldwide economic damage from catastrophes totaled $380 billion, $105 billion of which was insured.

U.S. catastrophe losses in 2011 approached record levels, too, according to Munich Re. U.S. economic damages hit about $75 billion, $35 billion of which was insured. These included:

  • With 552 fatalities, 2011 was the deadliest year for tornadoes since 1925, and April marked the most active month ever with 748 observed twisters.
  • Thunderstorms caused $25.8 billion of insured damage, with two separate storm systems each causing at least $6 billion of insured losses. Since 1980, annual insured losses, adjusted for inflation, have grown from less than $2.5 billion to more than $8 billion in six of the past 10 years.
  • The lower Mississippi River flooding was the worst since 1927, causing $2 billion of economic damage and $500 million of insured damage.
  • With more than 8 million acres consumed, 2011 was the fourth-worst year for wildfires since 1980.
  • Insured losses from winter storms continued to drift higher, hitting $2 billion last year, or nearly double the average losses during the early 1980s.

The losses had a notable financial impact on U.S. insurers. In December, A.M. Best reported that net income for U.S. property/casualty insurers fell 61 percent during the first 9 months of 2011 compared with the industry’s performance for the same period in 2010.

Related: Read the article "Nearly $2B in Cat Bonds Closed During Another Busy Quarter" by Mark E. Ruquet.

Catastrophe losses also ate up a chunk of U.S. insurers’ policyholder surplus last year, dropping the year-end total to around $539 billion from around $560 billion a year earlier, according to Nate Berns, a vice president in the Atlanta office of wholesale broker Risk Placement Services Inc.

Even so, insurers "are still in very good shape" financially, as surplus still exceeds the $522 billion that insurers reported in the third quarter of 2007 at the outset of the world’s financial crisis, Berns noted.

For U.S. insurance buyers with catastrophe exposures, the near-record insured catastrophe losses last year will not likely substantially affect how much catastrophe risk the insurance market shoulders, said Robert P. Hartwig, president of the Insurance Information Institute of New York.

While annual economic losses from catastrophe have mounted over the past few decades, U.S. insurers typically have covered about half of those losses, although "that can vary a little," Hartwig said. The same long-term trend also is evident in other countries with robust insurance industries, he said. Hartwig doesn’t expect that to change, unless the less frequently insured earthquakes and floods occur more frequently.

2012 impact

So what do last year’s losses mean this year for U.S. insurance buyers with catastrophe-exposed property?

That depends on how hardened the risk is to a catastrophe, the property’s construction and location and the amount of room an insurer has in its portfolio for another account in a high-risk area, according to brokers.

Generally, though, the 2011 losses coupled with higher treaty reinsurance rates for property insurers will mean costlier renewals this year for buyers with catastrophe risks.

For example, buyers with Florida windstorm risks face increases of up to 15 percent, said David Pagoumian, president and CEO of wholesale broker NAPCO LLC of Iselin, N.J. Only buyers whose expiring programs were not properly marketed and placed can expect rate cuts, but those buyers already have paid too much for coverage, according to Pagoumian.

Related: Read the article "Swiss Re: Global Earthquake Risk ‘Vastly Underinsured’" by Chad Hemenway.

Any risk either located in a "heavy" catastrophe zone or with significant catastrophe losses should expect rate hikes of 15 percent to 20 percent and possibly greater this year, Berns said.

But midsized to large buyers with cat risks may not have as tough a market ahead. For those purchasing all-risk coverage during this first quarter, rate hikes should range from 7.5 percent to 12.5 percent, said David Finnis, an Atlanta-based executive vice president and the North American property practice leader at Willis North America, a unit of London-based Willis Group Holdings PLC. Finnis projected that rates for stand-alone earthquake coverage would jump 5 percent to 10 percent.

Meanwhile, many insurers have reduced the capacity they will offer, so buyers have to build their programs with more insurers. But with the influx of new insurers in the market since 2005, buyers can find the capacity to build the program they want, brokers said.

Earthquake insurance rates are relatively stable, Pagoumian said. But insurers in 2010 and especially 2011 began bumping up the cost of quake coverage for Midwestern and Southern risks exposed to the New Madrid fault. Previously, insurers "just threw in" coverage for that peril, he said. But California quake coverage remains far more expensive, he said.

FEMA aid questions

Federal financial assistance in the wake of a catastrophe is not as sure a thing for public entities.

More than 4 years after the Federal Emergency Management Agency said it would dramatically pare the amount of financial assistance it would provide public entities that sustain property damage during a national disaster, public entity risk managers still do not understand what help they can expect from the agency.

FEMA introduced its plan in June 2007 but rescinded it several months later under a storm of protest from public entities and then reintroduced it in 2008. At the time, agency officials explained that the change would bring the agency into compliance with the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

FEMA said it would severely reduce the amount of aid it again would provide public entities that sustained damage to a facility that previously had been damaged or destroyed in the same kind of national disaster that had most recently damaged the facility.

But the agency developed drastically different calculations for determining how much financial assistance it would provide for flood- and non-flood-related losses, with calculation for flood losses being far more generous. Public entities with flood losses would be subject to a deductible equal to the amount of FEMA’s previous financial assistance. But those with non-flood losses would be subject to a deductible equal to the total amount of the previous loss, which could have been many times larger than the amount of FEMA aid the public entity received.

FEMA also imposed insurance requirement on public entities.

In the fall of 2008, a FEMA official said the agency recognized the inconsistency of its financial assistance calculations and was working on reconciling them by sometime in 2009, effectively tossing out the non-flood calculation.

While the 2009 target date passed without a change, James Walke, director of FEMA’s Public Assistance Division at that time, said he was continuing to work on the issue.

In January, FEMA’s press office denied that two formulas ever existed. It also would not directly answer other questions on the issue but instead referred to FEMA documents that public entity risk managers have said are unclear. FEMA also would not make Walke or his successor available for comment.

"There’s a lot of confusion about how FEMA does the things that they do," said Dan Hurley, president-elect of the Public Risk Management Assn. and senior director, risk management and safety for public schools in Norfolk, Va.

The situation creates challenges for insurance brokers and agents, too, said Nancy Sylvester, a Baton Rouge-based managing director in the Public Entity & Scholastic Division at Gallagher Risk Management Services Inc., a unit of Arthur J. Gallagher & Co.

For example, because of how the Stafford Act is worded, FEMA bases its financial assistance decisions on damage to specific buildings, Sylvester said. But "some insureds’ property schedules track data by location in lieu of each building."

As a result, "it can be tremendously difficult to turn the insurance claim information into data useable by FEMA," Sylvester said.

Add to that a modified windstorm damage model that is telling insurers that buildings with classrooms are much poorer risks than other types of buildings typically found on a school campus, and buyers and brokers have to consider that "aggregating all buildings on a blanket basis per location may not be the best decision," Sylvester said.

Terrorism coverage

For at least the 3 years, property owners can purchase federally backstopped terrorism insurance under the Terrorism Risk Insurance Program Reauthorization Act of 2007. TRIPA, the second extension of the original terrorism insurance program that Congress crafted in 2002 in response to the Sept. 11, 2001 terrorist attack, runs through 2014.

Under the program, an insurer underwriting a buyer’s standard property risk also must provide terrorism coverage if the client requests it.

If a terrorism event causes at least $100 million of insured damage, the federal government will backstop the insurance industry up to $100 billion annually.

But the industry’s retention would be substantial. The industry’s aggregate retention must total $27.5 billion; individually, each insurer would be subject to a deductible of 20 percent of its gross written premiums for its commercial property-casualty insurance book of business. In addition, insurers are subject to a 15 percent co-insurance requirement.

The coverage can be expensive in cities and for risks considered prime terrorism targets, and rates rise as an insurer’s terrorism capacity shrinks, said Wendy Peters, a Radnor, Tenn.-based senior vice president in the terrorism practices group at Willis North America. But insurers will "throw in" terrorism coverage "for a relatively low cost" for what they consider low-risk clients outside of major cities, she said.

Read related: "RMS: Domestic Terrorism, Soft Targets Present 'Credible Threat' to U.S."

"You don’t have to be a target to suffer a terrorism loss; look at 9/11," Peters said. In addition, not all acts of terrorism stems from religious extremism. Domestic animal rights groups, environmentalists and militias also are perils, she said.

Still, in major metropolitan areas, between 80 percent and 90 percent of commercial property risks have purchased the coverage, Peters said. Nationwide, however, the take-up rate is much smaller—60 percent to 65 percent, she estimated.

Besides having no guarantee that Congress will reauthorize the program and make terrorism insurance available after 2014, the current coverage has notable limitations, Peters pointed out.

For example, TRIPA does not require that insurers cover losses from fire following an act of terrorism, Peters noted. States can impose that coverage mandate on insurers, but only 29—including California, Illinois and New York—have, Peters said.

TRIPA also does not require that insurers cover losses arising from a nuclear, biological, chemical or radiological (NBCR) attack, although the program will backstop insurers that voluntarily offer such coverage. Few insurers do offer NBCR coverage, however, and the coverage is expensive when available, Peters said.

A few large property owners have engineered some NBCR coverage by forming captive insurers, which are eligible for TRIPA protection, Peters noted. But those backstopped captives would be subject to TRIPA’s 20 percent deductible and 15 percent co-insurance requirements.

Many of those captives purchase reinsurance that would be triggered in the event of a terrorism event that causes $100 million of total insured damage. Under such a reinsurance arrangement, the captive "is only on the hook for 15 percent" of its losses as a result of a co-insurance requirement, she said.

There is a segment of insurance buyers, however, that believes the federal government would step in to cover the cost of rebuilding if terrorists successfully launch a nuclear strike, Peters noted. To those buyers, NBCR coverage is not a sound purchase.

"I don’t agree with that" assumption, she said.

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