Consumer Groups Bash Hurricane Models

Hurricane risk projections used by insurers to hike property coverage rates in coastal states are “severely flawed,” and state insurance regulators should reject them, two consumer groups contend.

The call, directed at individual regulators and the National Association of Insurance Commissioners, came from the Washington-based Consumer Federation of America and the Center for Economic Justice in Austin, Texas.

This is the second time in a year that the groups have questioned insurer use of catastrophe modeling and rating.

The organizations said computer catastrophe models developed by Risk Management Solutions, Applied Insurance Research and EqeCat to estimate future damage from weather events and set homeowners insurance rates have historically been based on over 100 years of historical data.

They noted that last year, RMS announced it would dramatically increase projected catastrophe losses in some coastal areas, based on a “near-term” forecast of only five years.

The consumer groups said RMS explained this change was necessary because hurricane activity over the next few years will be above the historical average.

They said this revision has led to rate increases of 25 percent in Maine, and 50 percent or more along the Gulf Coast.

“We informed the NAIC a year ago that modeling changes made by RMS would lead to unjustified rate increases for consumers, but the NAIC and every state–with the exception of Florida and Georgia–failed to act to protect consumers,” said J. Robert Hunter, CFA's director of insurance.

“Since that time, rates have risen sharply in coastal areas, and impartial scientists have strongly criticized the use of 'near-term' projections by RMS and other firms that have increased estimated loss costs by up to 90 percent in some areas,” he said. “Even one of the firms that markets catastrophic risk models, AIR Worldwide Corp., has criticized the practice.”

AIR said the press release did not misrepresent its views on projections, but it had no further comment.

However, Mitch Sattler, vice president of public policy at RMS, responded via e-mail that the consumer groups' letter “misrepresents the work of RMS. The objective risk-metrics provided by RMS models are based entirely on science, and are in no way driven by any collusive practices or pressure to produce results that appear to be favorable to the insurance industry.”

RMS added that its model “reflects the widespread agreement among researchers that hurricane activity in the North Atlantic has increased since 1995, and that this period of elevated activity will last for at least another 10 years. The long-term historical average thus significantly underestimates the hazard posed by hurricanes for the foreseeable future.”

RMS said “there are clear limitations to models that produce a static view of risk that relies solely on the historical long-term average. Ignoring this fundamental fact only steers discussion away from the vital issue of determining the best actions for mitigation and other risk reduction measures.”

RMS noted that it has submitted its hurricane model to the Florida Commission on Hurricane Loss Projection Methodologies for approval, “and we fully expect it will recognize the rigorous science upon which our work is based.”

CEJ Executive Director Birny Birnbaum said “it is a sham for RMS to claim that its catastrophe models are scientifically sound when they make an ad hoc adjustment at the end of the process that doubles loss projections.”

He added that “the NAIC claims the primary job of state insurance regulators is consumer protection, but it has done nothing to protect consumers from massive and unjustified rate hikes. It is a sad commentary on state insurance regulation that consumer groups have to repeatedly demand that regulators take action to stop these dramatic and unfair increases.”

Scientists and insurance experts have increasingly questioned the scientific legitimacy of the modeling changes, according to the consumer groups.

In announcing the change last year, the consumer groups said RMS had “admitted” the shift to a “near-term” loss projection was done in consultation with its insurer clients.

“RMS has become a vehicle for collusive pricing,” charged Mr. Hunter. “The huge increase in rates that ultimately occurred because of inaction by NAIC and several states was due to pressure from insurers.”

Florida, the consumer groups noted, did not allow the new model to be used by primary insurers nor, it appears, has Georgia. However, residents of the 16 other states along the coast have been paying higher rates solely because of the changes adopted by RMS and other modelers, they said.

CFA and CEJ wrote the NAIC last March and again earlier this month urging it to reject the new modeling methods and immediately increase regulation of non-insurer organizations, whose work has a significant impact on insurance rates and availability.

Tom Larsen, senior vice president of EqeCat, said the heightened risk in the prospective near term over the next five-to-10 years “is very real and dependable in the scientific community.”

“Our clients are competing with bankers and other investment funds who are already pricing risk corresponding to those near-term risks,” he said, adding that to avoid doing the same would put insurers at a competitive disadvantage.