Location, location, location: Higher property values increase potential catastrophic losses

The cost to replace residential and commercial properties destroyed by natural disasters has continued to rise faster than the general economy, primarily due to increasing construction costs per square foot. For example, for U.S. residential properties, average costs can range from a low of $45 in some areas of the country to a high of more than $250 in New York and San Francisco. Certain properties, such as healthcare facilities, can cost more than $350 per square foot to rebuild while lower value buildings, such as parking garages, are closer to $50 per square foot on average.

Source: Report, Karen Clark & Company

The U.S. state with the most property value is California, followed by New York and Texas. The top 10 states account for more than 50% of the U.S. total.

Source: Report, Karen Clark & Company

The U.S. vulnerability to hurricanes and other coastal hazards continues to rise because of increasing concentrations of property values along the coast. Of the $90 trillion in total U.S. property exposure, more than $16 trillion is in the first tier of Gulf and Atlantic coastal counties, an increase from $14.5 trillion in 2012.

"The $90 trillion estimate includes the cost to rebuild these properties as well as the contents and time element exposures, such as additional living expenses," explains Karen Clark, president and CEO of the company that bears her name.

(Photo: marekuliasz/Shutterstock)

Increasing probability of mega-catastrophes

As property values continue to rise and become more concentrated in areas prone to natural disasters, the probability of a mega-catastrophe loss increases. The report notes that no major hurricane or earthquake has occurred in a densely populated urban center for decades. When a 100-year event does occur in one of these areas, the report predicts that the property damage and economic loss will dwarf the losses from Hurricane Katrina and Superstorm Sandy.

"The 100-year benchmark refers to the event, not the 100-year loss," says Clark. Traditional models, such as the one that she developed for Applied Insurance Research (AIR), the company she founded in 1987, output the Exceedence Probability (EP) curves that provide the probable maximum losses, or PMLs, companies use to manage risk. Insurers currently manage their potential catastrophe losses to the 100-year PMLs, but because of increasingly concentrated property values in several major metropolitan areas, she explains, the losses insurers face from the 100-year event can greatly exceed their estimated 100-year PMLs.

Clark, one of the founders of catastrophe modeling firm Applied Insurance Research (AIR), understands well the use of computer models and data to help manage risk from catastrophes. After she sold AIR to Insurance Services Office in 2002 she began consulting for companies of all sizes and heard them say that they were dissatisfied with the traditional model. It wasn't transparent enough, and they couldn't understand the factors that were used to develop the models.

Catastrophic event model

The traditional models generate thousands of possible events, then calculate potential losses, Clark says. But while this is an important mathematical exercise, it doesn't provide insight into particular events. To meet client demand, Clark and her team developed the Characteristic Event (CE) approach, captured in RiskInsight®, an open global platform for catastrophe risk assessment and management. The CE approach provides more understanding about the types of events companies might encounter and a new perspective, she adds.

"The Characteristic Event technique defines the 100-year event in reference to a specific location," Clark explains. For example, the modeling team plotted landfall points at 10-mile increments and asked themselves, "What would be the 100-year hurricane here that companies should be prepared for?" Then, they used scientific information to create those events in order to calculate the potential losses.

Harris County, Texas, which includes the city of Houston and the Woodlands-Sugar Land area, is one of the six counties in the U.S. with more than $1 trillion in property values. The below chart shows the industry losses that would result from the 100-year hurricanes making landfall at different points along the Texas coastline. A 100-year hurricane making landfall near Galveston would cause industry losses far higher than the estimated industry PML for the state of Texas, the report points out. The model-estimated 100-year PMLs range from $40 billion to $50 billion, with the largest losses estimated to be more than $100 billion.

The map shows the wind footprint that would create the largest loss of $180 billion. According to this storm track, the peak winds would be over Houston, with its increasing property values and increasing potential losses.

Source: Report, Karen Clark & Company

(Photo: Dalrymple Art/Shutterstock)

"Catastrophic risk grows through demographic changes more than anything else," Clark says, "and companies haven't had sophisticated tools for monitoring the effect of exposure concentrations on their risk." With the CE approach companies can adjust their underwriting guidelines so they spread the risk and don't build up potential solvency-impairing concentrations.

It's déjà vu

In her first five years with AIR, most insurance companies didn't value the hurricane model that Clark had developed. They didn't think they needed something new when the old techniques had worked well enough. "Then Hurricane Andrew hit in 1992," Clark says, "and companies realized that the model could help them manage risk."

Fast forward to today, and Clark finds herself in a similar situation. With the CE approach she has identified another advanced way to model and manage catastrophe risk, but some insurance companies are reluctant to try something new. Many companies think, "I don't need this if I get the model PMLs." "But the 100-year event could put companies out of business," she says. "If you had another sophisticated tool at your disposal to help you manage catastrophic risk, why wouldn't you use it?