AIR Urges Insurers to Think Globally, Rather Than Regionally, on Cat Risks

While 2011 produced significant insured losses from natural catastrophes, AIR Worldwide says in a recent report that it sees little evidence that catastrophes are becoming more frequent and severe, stating that increases in losses are primarily the result of having more exposures in catastrophe-prone areas.

“Even as companies understand the potential for loss years like 2011, they continue to question just what drives them,” says the report, “Taking a Comprehensive View of Catastrophe Risk Worldwide.”

It continues, “Indeed, a question commonly posed by researchers and risk managers alike is whether natural catastrophes are becoming more frequent and severe.” 

But AIR says that, during the current period of warmer-than-average Atlantic sea-surface temperatures (SSTs), 32 loss-causing hurricanes impacted the U.S. While some years show landfall counts “closely aligned with the view of risk reflected in AIR's warm-SST conditioned catalog,” the catastrophe modeler says the current final tally “closely agrees with AIR's standard long-term view of U.S. hurricane risk, which considers all years since 1900. 

“It is AIR's view that increases in natural catastrophe-related losses are primarily driven by the increase in and distribution of exposures in areas susceptible to natural perils,” the firm says. “As the number of properties in highly-exposed areas of the world and the overall penetration of insurance increase, insured losses from natural catastrophes will only continue to rise.”

But AIR says that loss years such as 2011 show the toll catastrophe risks can take on insurance and reinsurance companies that are globally exposed. “Such companies need to ensure they fully grasp their far-reaching risk profile,” AIR says. “They must ascertain they have enough capital to survive years of very high loss—potentially significantly higher than we saw in 2011. They must also understand how frequently they will face such years, as well as the variety of events that could comprise them, including contributions from non-peak regions and perils. Finally, they need to be prepared for the possibility that future catastrophes will produce losses exceeding any historical amounts.”

Citing figures from Swiss Re, AIR says 2011 saw 175 natural catastrophes—including earthquakes in Japan and New Zealand, flooding in Thailand, and tornadoes in the United States. The events caused the second-highest insured-loss tally, says AIR, at $110 billion, since Swiss Re began publishing data in 1970. 

But AIR notes the the year did not cause any insolvencies, “a testament to an improved approach to catastrophe-risk management, aided in no small part by the use of catastrophe models.”

AIR notes that 2011 “did prompt the insurance industry to consider how to put the losses in perspective.”

In its report, AIR attempts to show the advantage of taking a global perspective on preparing for future losses rather than a regional view. AIR explains that an insurer focused only on the immediate area where the Japan Tohoku earthquake struck would see that the event had an extremely low exceedance probability for that region. But for Japan as a whole, “it has a considerably higher exceedance probability, at roughly 0.90 percent,” AIR says. “It has an even higher exceedance probability, roughly 4 percent, with respect to global earthquake risk.”

AIR also points to a Hurricane Katrina-type of event, noting that “the annual probability of experiencing a Katrina-sized hurricane loss or higher in the state of Louisiana is about 0.08 percent, but it increases dramatically—to nearly 5 percent—when considering the U.S. as a whole.”

The firm states, “Not surprisingly then, evaluating portfolio risk based on regional losses can significantly underestimate the actual risk for companies with global exposures. Yet this approach is not unheard of in the industry today; for example, companies are known to estimate their U.S. hurricane losses by region and purchase reinsurance to cover their largest regional loss.”