Heading for the coasts: 105 coastal strikes in 55 years. Yet construction and insurers' liability continue to rise.

As the 2007 hurricane season dawns June 1, insurers are paying attention to weather forecasts and their balance sheets.

But, like the smartest of the three little pigs, insurers are confident that their financial homes are made of brick and strong enough to withstand the winds.

"We know that the predictions are for an above average hurricane season, not only for more storms, but for more intense storms," said Robert Hartwig, president and chief economist of the Insurance Information Institute.

While 2006 turned out to be a mild year for hurricanes, that is no reason to doubt the current predictions, Hartwig said.

"Just because you stand in the middle of a highway, and the first car misses you, doesn't mean you are safe. You are still in the middle of a highway, and better take precaution," Hartwig said.

Insurers are approaching the 2007 season "with much trepidation. But they are confident they'll be able to handle the losses that occur," he said.

The Preparation

By the time the first hurricane wind blows this summer, insurers will have built their claims-paying resources to half a trillion dollars, for the first time, Hartwig said. Insurers have reinvested the record gain of about $32.5 billion at year-end 2006.

"The lion's share of profits earned in 2006--which was a record in dollar terms--has been reinvested in the industry," he said.

Insurers have made greater use of capital markets, spreading risk to investors through catastrophe bonds, which hit records in 2006. The reinsurance market largely has stabilized with the new capacity entering the market after hurricanes Katrina, Rita and Wilma, Hartwig said. 2005 was by far the worst year ever for insured catastrophes in the United States, with insurers reporting $62.1 billion in losses, more than double the previous record year of 2004.

Homeowners insurers have raised rates and used hurricane deductibles (See page 28) to help limit their exposure. While some companies have backed away from offering insurance in coastal areas, others have viewed this void as an opportunity and moved in. They may be asking for more premiums for the coverage, but insurance is available, Hartwig said.

And, the industry financially is prepared for events that even may be more severe than Katrina, Hartwig said.

"The strong performance in 2006 provided the opportunity for the industry to fortify its financial strength, reduce exposures and enhance risk management strategies," said Anthony Diodato, vice president of A.M. Best Co.'s Property/Casualty Division. "Individual companies that remain overexposed or have not expanded risk management initiatives will be challenged to maintain their financial strength increased hurricane activity is projected for the near term."

The Big One

Hartwig warns that the $100 billion catastrophe is coming and very well could come in the form of a hurricane.

With close to $2 trillion in insured property on the coast--half of it residential--Florida as the largest exposure of any of the 18 states facing hurricane risk. The city of Miami faces exposure similar to New Orleans, but has property valued at several times that of the Louisiana city. If a Katrina-like storm were to hit Miami--such as the Great Miami Hurricane of 1926--it would produce insured losses of about $100 billion.

While some homeowners insurers have fled the Florida market, the Florida Citizens Property Insurance Corp., the state-run insurer of last resort, entered the year with about $408 billion in exposure, but little more than $1 billion in cash in hand, Hartwig said. The Florida Legislature acted in January to expand Citizens and lower the rates it charges. It also expanded the Florida Hurricane Catastrophe Fund, the state-run reinsurer, increasing its exposure to $32 billion from $16 billion.

"Most future losses will have to be covered through a combination of debt and assessments," Hartwig said. "One of the ironies is that the risk in Florida has never been more concentrated. More of the risk now rests squarely on the shoulders of the people of that state, rather than being distributed across the world through reinsurers."

Foreign reinsurers absorbed 45% of the 2005 cat losses, which helped contribute to surplus growth of U.S. insurers, the Insurance Information Institute said.

While a $100 billion catastrophe would bankrupt Citizens and the Florida cat fund, most private insurers would sustain heavy but manageable losses, Hartwig said.

One Nightmare Scenario

Miami could be overdue for such a storm.

The return period, or average of how many years are between storms striking a certain area, is nine years for a Category 3 or higher storm hitting Miami-Dade. Hurricane Andrew, which was a Category 5,was in 1992--15 years ago.

While Florida Gov. Charlie Crist has been a strong advocate of the need for a federal catastrophe fund, the state has not slowed its development along the coast, Hartwig said.

While the risk of a hurricane is elevated, the value of the property exposed continues to grow and shows no sign of slowing.

Along South Miami Beach, some 15 new high-end condo developments are under construction from 2007 to 2009. They are expected to bring an additional 2,111 units onto the market at an average price of $3.7 million. Buyers likely will have to purchase insurance from Citizens.

Galveston, Texas, is also overdue for a catastrophic storm. Its return period is about 20 years. Even though the area has been hit by more recent storms, it was more than a century ago when Galveston Island was devastated by the deadliest hurricane ever. The Galveston Hurricane of 1900 killed 8,000 people.

But that hasn't stopped development from continuing along Galveston's coast.

It's a more remote possibility, but a storm targeting New York and New Jersey could also cause major losses. "It's never happened, but theoretically, a strong Category 3 or weak Category 4 coming into New York Harbor could cause $110 billion in insured losses," Hartwig said.

The Forecasts

Colorado State University and Tropical Storm Risk have both predicted a more active hurricane season. Philip J. Klotzbach and William M. Gray of Colorado State have estimated there's a 74% chance of at least one major (Category 3 or higher) storm making landfall somewhere along the U.S. coastline.

Insurers pay attention to these seasonal forecasts, as well as short-term weather forecasts for the next five days or so, but they are most interested in long-range forecasts that stretch five to 15 years, said Tom Larsen, senior vice president of catastrophe modeler, Eqecat.

"Companies can use those longer-term forecasts and integrate them into a strategic plan. Do they want to write more business? Where do they want to back off?" Larsen said.

These seasonal forecasts can impact reinsurance purchases, say if a company decided it wanted to purchase a little extra coverage. Industry Loss Warranties, a type of reinsurance contract with one trigger--a set industrywide loss--can be purchased even as a storm is approaching land.

Also, both insurers and reinsurers try to harness information to be in a better negotiating position when buying--or selling--reinsurance, Larsen said. "If you have better information, you can make a better decision than the other person on the other side of the table. Both insurers and reinsurers spend a lot of time trying to understand the impact of weather predictions."

Other noninsurance entities can buy catastrophe bonds and hedge them by purchasing commodity futures. For instance, a hedge fund could purchase oil futures, betting that a bad hurricane season would damage oil rigs, and cause the price of oil to skyrocket.

Some hedge funds may place bets in the market based on seasonal hurricane forecasts. But by the time seasonal forecasts come out, homeowners insurers have already set their rates and issued their policies, so there's not much they can do--other than activate their emergency response people and claims team if a hurricane landfall is imminent.

"Rates and policies are set. They aren't based on someone else's prediction," said Dick Luedke, a spokesman for State Farm, the largest homeowners writer in the United States. "They are based on data over a longer period of time. It's historical data as opposed to forecasting the future. Aberrational as hurricanes are, actuaries have learned you're better off going with a longer period rather than a shorter period, and the best predictor of the future is what happened in the recent past."

State Farm is not writing new business in the entire state of Mississippi. That's due partly to the risk of hurricanes, but also, the legal environment in the state is "unpredictable," Luedke said.

Farmers Insurance Group, the third-largest writer of homeowners in the United States, does not write along the coast, said spokesman Jerry Davies.

And the second-largest homeowners writer, Allstate, said the latest reports predicting a more active season do not have a direct impact on the company, said spokesman Mike Siemienas.

"We feel we are prepared for the upcoming season" Siemienas said.

Key Points

* Insurers are expecting a heavier than usual hurricane season.

* Insurers have reinvested their record profits from 2006 into reserves that could be used to pay claims in 2007.

* Industry experts warn that due to coastal development, a $100 billion hurricane is a real possibility.

Learn More

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The Heart of a Hurricane Prediction

Dr. Peter Dailey, director of atmospheric science for research and modeling at AIR Worldwide, said hurricanes are "really heat engines. They have the purpose of redirecting excess heat in the tropics to the middle latitudes. That's the role they play in the atmosphere."

Hurricane Season

Hurricanes have a particularly strong influence in the summer, when the Atlantic Ocean is warmer. The vast majority of hurricanes occur during the "official" Atlantic hurricane season, which runs from June 1 through Nov 30, although hurricanes and cyclones can occur outside of those dates. August to October tend to be the busiest hurricane months, with activity peaking in early to mid-September, according to the Atlantic Oceanographic and Meteorological Laboratory.

Heat Factor

The heat of the ocean is one major factor in predicting how busy a hurricane season will be. When the ocean is warmer than average, you can expect elevated hurricane activity. And the ocean is warmer than average this year.

However, since 1960, the Atlantic has been warmer than average 23 years. During those 23 years, six years saw below average hurricane activity, despite the warmer waters. "It's important to incorporate other factors and uncertainities into your prediction," Dailey said.

Wind

Another major factor is wind sheer.

"Hurricanes like environments where there is no wind sheer, so it doesn't disrupt the efficiency of the heat engine," Dailey said.

Last year, El Nino, a major warming of the equatorial waters in the Pacific Ocean, created elevated wind sheer. El Nino means "Little Boy" or "Christ Child," because it often happens around Christmastime. It occurs every three to seven years.

Dust Storms

Another important factor is the Saharan Air Layer, which refers to how much dust storms in the Sahara Desert blow into the Atlantic Ocean. The dust diffuses sunlight, cooling the ocean, and also can inhibit the formation of clouds and precipitation, all of which contributed to suppressed hurricane activity in 2006, Dailey said.

"Even the best of science and technology are still making predictions on a highly complex and uncertain system," Dailey said.

Strong Winds Stop Soaring Stocks

Hurricane forecasts can impact the stock price of insurance companies, said Robert Hartwig, president and chief economist with the Insurance Information Institute.

"Investors are approaching the 2007 hurricane season with some trepidation, too. Last year, the forecast for a difficult season kept property/casualty insurers and reinsures' stock prices flat or in the negative territory as investors anticipated what was likely to be a heavy hurricane season. By the middle of September, when it became clear the season wouldn't be as bad as expected, insurance stocks greatly outperformed the market after underperforming for the past nine months. That could happen again this year," Hartwig said.

However, John Williams, senior business analyst at A.M. Best Co., said last year's predictions dampened more than just insurance stocks.

"Early expectations for a severe 2006 hurricane season hit the broad stock market, in general," Williams said. "With oil prices already at record highs, some analysts were concerned that a major hurricane in the Gulf of Mexico would drive oil and gasoline prices to much higher levels, seriously damaging economic activity. As concerns over the severity of the storm season waned, so too did some of the pressures on energy prices. The broad market rallied partially in response to that circumstance."

He noted A.M. Best's index of reinsurance stocks closely mirrored the performance of the Dow Jones Industrial Average during the hurricane season last year.

Hurricane Deductibles

After Hurricane Andrew in 1992, many coastal states adopted wind storm or hurricane deductibles, which are percentage deductibles based on the value of the insured home, rather than a traditional flat dollar deductible. For instance, a homeowner with a policy with a $500 standard deductible would be responsible for paying the first $500 of a standard claim, say for fire or theft. But if the home was insured for $100,000, and the policy had a 2% wind storm deductible, the homeowner would be responsible for the first $2,000 of a claim related to damage from a wind storm.

The hurricane or wind storm deductible is triggered by events defined under various state laws. Some may apply when the National Weather Service names a tropical storm, declares a hurricane warning or watch, or defines the hurricane's intensity. Triggers usually include a timing factor, say damage occurring within 24 hours before the storm is named or a hurricane makes landfall, up to as long as 72 hours after the hurricane is downgraded to a lesser storm or the hurricane watch is cancelled.

Percentage Deductibles

Eighteen states have hurricane or windstorm deductibles which are percentage deductibles based on the value of the insured home.

[ILLUSTRATION OMITTED]

As the Risk Grows

New Miami South Beach Condo
Construction

2007-2009

15               Number of new developments
2,111            Number of individual units
$3.7 million     Overall average price per unit
$6 billion       Aggregate property value

Source: Insurance Information Institute from
www.miamicondolifestyle.com as of April 5, 2007

Hurricane Facts: Do You Feel Lucky?

* 2006 was only the 12th year since 1945 without a hurricane making landfall in the United States.

* Since 1945, only twice have there been two rears in a row without a hurricane making landfall: 1981-82 and 2000-2001.

* From Hurricane Irene in 1999 to Hurricane Lili in 2002, there were 21 hurricanes in the Atlantic basin, but not one made landfall in the United States.

Source: Colorado State University

Probabilities for at Least One Major (Category 3-5) Hurricane Making Landfall in 2007

* Entire U.S. coastline: 74% (average for past century is 52%)

* U.S. East Coast, including Florida Peninsula: 50% (average for past century is 31%)

* Gulf Coast from Florida Panhandle westward to Brownsville, Texas: 49% (average for past century is 30%)

Source: Colorado State University

Total Value of Insured
Coastal Exposure, 2004

($ Billions)

Florida                      $1,937.30
New York                      1,901.60
Texas                           740.0
Massachusetts                   662.4
New Jersey                      505.8
Connecticut                     404.9
Louisiana                       209.3
South Carolina                  148.8
Virginia                        129.7
Maine                           117.2
North Carolina                  105.3
Alabama                          75.9
Georgia                          73.0
Delaware                         46.4
New Hampshire                    45.6
Mississippi                      44.7
Rhode Island                     43.8
Maryland                         12.1

Source: AIR Worldwide

Note: Table made from bar graph.

2007 Atlantic Hurricane Predictions

                              Named                       Major
                             Storms    Hurricanes    Hurricanes

Colorado State University        17             9             5
Tropical Storm Risk              17             9             4
Weather Research Center           7             4           N/A *
Average from past 57 years       10             6             3

* WRC predicts a 50% chance of a Category 3 or higher storm
forming in the Atlantic.

Sources: Colorado State University, Tropical Storm Risk, Weather
Research Center