Storm warning: if Hurricane Andrew struck the same area today, insured losses could be nearly double what they were 10 years ago. (Cover Story).

Super-charged Hurricane Andrew swept through Homestead and southern Dade County; Florida, on Aug. 24, 1992, packing sustained winds of 140 mph and gusts of at least 175 mph. The storm killed 43 people and destroyed or damaged more than 86,000 homes, 10,500 mobile homes and more than 38,600 apartments and condominiums in the area. The devastation ultimately added up to about $16 billion in insured losses, making Andrew the costliest hurricane in U.S. history.

In the nearly 10 years since Andrew struck, South Florida has seen a steady population growth--residents in Dade County, now called Miami-Dade County, number 2.3 million--with a 17% increase in the building of commercial and residential units. With this in mind, catastrophe-modeling experts--who habitually pose "what-ifs" in their line of business--say that if a storm like Andrew were to strike the same area this hurricane season, the insured losses would be staggering, ranging from an estimated $20.3 billion to $30 billion.

"Clearly, catastrophes bring a lot of disaster and ruin to the people affected," said Robert Muir-Wood, head of the global risk modeling group for Risk Management Solutions, Newark, Calif. "But for us in catastrophe modeling, catastrophes are a huge opportunity to learn as many lessons as possible by which to reduce or mitigate the potential for losses in the future."

And of all the hurricanes that have occurred in the past 20 years, Andrew was the most important for helping researchers gain a real understanding of what happens to certain types of buildings at very high wind speeds, he said.

Catastrophe models employ sophisticated stochastic simulation techniques to generate large samples of potential catastrophes. The idea is to anticipate the likelihood and severity of these events, so insurance companies can gird for their financial impact. In the worst-case scenario, the industry fears it could face multiple super-catastrophes in a single year.

In the view of RMS, if Hurricane Andrew were to happen in South Florida this season, the area could expect a total loss of about $23 billion, broken down to about $8 billion in commercial losses and just less than $15 billion in residential losses.

For his part, Kevin Campion of independent reinsurance broker Benfield Blanch predicts that an Andrew-like storm this year in the same area could result in insured losses, commercial and residential, of about $24 billion.

"What's interesting about that is there has been an increase in deductibles from $500 to 2% on a significant portion of the business in Florida, and that has mitigated the growth in that loss," Campion said. If those higher deductibles had not been implemented, insured losses could climb into the neighborhood of $26.5 billion, he noted.

Greater Numbers, Higher Value

At Applied Insurance Research Inc., Boston, a catastrophe modeler, the expectation is that a present-day Andrew would wreak losses from $25 billion to $30 billion, said Karen Clark, president and chief executive officer. This estimate is based on the increased number and value of building units in Miami-Dade County since 1992, Clark said. She pointed to growth in the area's commercial and residential units--about 17% from 1992 to 2002--as well as a 50% increase in replacement value of individual properties. "When you combine these, you get a compounded growth rate of almost 80%," she said.

Just before Andrew slammed into South Florida, AIR was estimating potential hurricane losses in that area of $20 billion to $30 billion "and nobody believed it," Clark said. Four hours after Andrew made landfall, AIR issued a report of estimated losses exceeding $13 billion--"and nobody believed that as well," she said.

One of Andrew's many legacies was to give catastrophe modeling greater credibility in the insurance industry. Modeling is now seen as the most reliable tool for estimating the loss probabilities and the effects of extreme events, AIR said. "Fundamentally, our hurricane model, in terms of its structure and how it works, is the same as it was before Andrew," Clark said. "The biggest change since Andrew is not so much in the modeling but in how insurance companies perceive the models and how much they are using them today."

Her company is considering adding the kinds of technological changes to its hurricane model that it has incorporated in its European windstorm model, Clark said. "If we go to this more physically based model approach, with Numerical Weather Prediction technology, we can use meteorological or climatological factors such as El Nino, La Nina or the North Atlantic Oscillation, and come up with a probability distribution that reflects the influence of these factors on hurricane activity," she said.

Before Andrew, catastrophe modeling was considered largely experimental, said Muir-Wood of RMS. After Andrew, "insurers and reinsurers recognized that their previous ways of trying to process risk had not really worked, and they were looking for a more scientific method of proceeding," he said.

"So, on the back of Andrew, catastrophe modeling of hurricanes swept through the industry. Three or four years later, all principal players in the market were using catastrophe modeling in some form or another."

In a way, the South Florida building code of 1994 evolved from everything that was understood in investigating how buildings performed during Hurricane Andrew, Muir-Wood said. "In the same way, we have worked with a number of the major insurers that suffered losses in Andrew," he said. "We've used their original information on those properties they were insuring at the time and the levels of loss to which those properties were subjected in order to ensure that we understand, in our models, how we can calibrate this relationship between wind speed and damage or wind speed and insurance loss."

RIMS researchers have just completed a two-year study of the many innovations in the science of hurricane modeling, and the company expects to release its next-generation hurricane model in February 2003.

A Single Building Code

Although building codes were strengthened in the hurricane-battered area by 1994, the formulation and adoption of Florida's first uniform state code took years longer and finally went into effect in March 2002. (See "Building a Better Building Code," page 22.)

"There were between 300 and 400 different versions of different codes out there that were being enforced, and so to consolidate that into one document that applied statewide was not an easy thing to do," said Nanette McElman, building code manager for the Institute for Business & Home Safety, Tampa, Fla.

The insurance community played a substantial role in helping to craft the statewide code, McElman said. The Florida Insurance Council, which is the state trade organization, supplied the legislative expertise, and the institute supplied the engineering know-how to the state building commission.

Recently, AIR collaborated with the institute to research the impact of these building-code developments on potential hurricane losses in Florida. The modeling firm looked at what the reduction in losses might be if all buildings in South Florida were to comply with the state's new code.

In the experiment, AIR used its Hurricane Individual Risk and Mitigation Analysis model to assess the wind vulnerabilities of construction in South Florida today. The outcome showed that if the building stock had been retrofitted to or built in compliance with the new code, the projected residential losses could be reduced by as much as 50% and commercial losses by as much as 40%. These reductions would translate to savings of about $8.1 billion in residential and $2.3 billion in commercial, the institute said.

As the institute points out in the executive summary of that joint research report, extensive building damage from Andrew "revealed a number of serious weaknesses in building construction practices in South Florida." These included failures of roofing attachment to roof sheathing, sheathing attached to roof framing and rake overhang details. Also, wind-borne missiles and/or high wind pressures caused breaches in windows, doors and garage doors, which often set off a chain of events that led to the loss of entire homes, the summary said.

To mitigate these losses, the new statewide code addresses proper wind-load calculations and protection of the building envelope. The code also establishes a High Velocity Hurricane Zone along the coastline, where continuous use of South Florida's more stringent code is required. The South Florida code in Miami-Dade and Broward counties requires that buildings be designed to withstand high internal pressures from strong winds as well as the impact of wind-borne debris, the latter design option having greater value when a hurricane hits, McElman said.

"That option provides a vast difference for performance in a structure during a hurricane," she said. "When you do not protect the openings of a house, you are sacrificing the contents and the insides of a structure. The structure may remain--the roof, the walls--but the insides will be open to damage from wind and rain." Impact-resistant windows and doors can stand up to high winds and flying debris, she added.

Under the state code, however, new home buyers outside Miami-Dade and Broward can choose either design option. "Those two counties have the most restrictive part of the code today, more so than any other counties," McElman said. "The rest of the state was not really prepared to adopt those stringent requirements."

Limited Protection

Even so, RIMS estimates that only about 15% to 20% of the building stock in South Florida has been constructed since 1994, when that area's tighter code took effect. "The buildings that have been built since then are clearly slightly less vulnerable--it doesn't prevent those buildings from suffering loss, but they suffer slightly less loss than they would otherwise," Muir-Wood said. "However, that reduction in the level of loss at a given wind speed is itself on the order of only 10% or less. Even if you replaced all the building stock in Florida with buildings constructed since 1994, it wouldn't have a completely dramatic effect in reducing the level of loss."

That's because, ultimately, there are limits to what can be done to protect a building in the path of a major hurricane.

"There's only so much they could do about a storm that comes through with 160-mph sustained winds with gusts over 200 mph," Brian Owens, RMS director of Risk Applications, said. "It's going to be very hard to put in a building code to require structures to withstand winds of that magnitude."

"If you look at the changes in the building codes, they're kind of incremental. They haven't told everyone to build their houses out of reinforced concrete," Muir-Wood said. "The construction practices are more or less the same, except they've just changed some of the detailing," such as the required thickness of roofing boards or the length of nails, he added.

It should be kept in mind that Hurricane Andrew was a relatively unusual and extreme event for that location, Muir-Wood said. So since Andrew, Floridians have had to weigh how much they wanted to reduce their risk, while at the same time keeping a lid on property costs. "It's that kind of trade-off that ultimately drives what are the incremental improvements that go into a building code," he said.

New Funds and New Choices

If a storm on the scale of Andrew were to strike today, the Florida Hurricane Catastrophe Fund, which was not in existence in 1992, would be able to cover its share of the residential losses in their entirety, said Campion of Benfield Blanch. The Cat Fund, which requires each insurer in the state to pay premiums into it, provides catastrophe reinsurance to the insurers if losses exceed a predetermined retention level.

The Cat Fund currently has $11 billion in claims-paying capacity devoted to residential hurricane losses, he said.

Another change is coming with the July 1 consolidation of the Florida residual homeowners market, composed of the Florida Residential Property & Casualty Joint Underwriting Association and the Florida Windstorm Underwriting Association. The wind pool, a residual-market program, is the largest single insurer of hurricane risk in Florida, with 23.7% of total Cat Fund premium, or $113 million, according to the Florida Insurance Council. State Farm is second, with 16.6%, or $79.2 million.

This change, along with the end of the post-Andrew moratorium that prevented insurers from nonrenewing policies, has left insurers pondering which policies they should drop and which they should keep.

To assist them, Benfield Blanch, which is very active in the Florida market, has developed a software tool called Dynamic Portfolio Optimization. This tool can identify which policies pose the greatest risk, which offer the best reward and which mix will result in the best probable maximum loss to premium ratio.

"It's important in trying to manage a Florida homeowners book to manage concentration of business, because one of the things that drives catastrophe loss is the correlation between individual policy losses. It's this correlation that drives losses into the higher layers covered by excess-of-loss treaties," Campion said. "Our model allows companies to analyze the correlation of individual policies within their portfolios to determine which ones are driving the [probable maximum losses], which, in turn, drives how much catastrophe reinsurance they need to purchase and, hence, their costs."

North to Miami

Hurricane Andrew has provided modelers with a large quantity of high-resolution, accurate and detailed loss data, Muir-Wood said. "Also, there's a very rich historical record of events affecting Florida, which now goes back 150 years, and which we can use for calibrating the activity rates of hurricane events in our models," he said.

That data has enabled RMS to model the impact of a major hurricane on modern-day Miami, some 40 miles north of Andrew's landfall. The company's reference is the unnamed storm that struck a direct hit on the city on Sept. 11, 1926. This hurricane came into what is now the port of Miami and the downtown area, Owens said.

"It was a slightly less intense storm than Andrew, but bigger, and its eye wall went right over Miami, so it really did a lot of damage in the city itself," he said. Also, as is typically the case with hurricanes, its strongest winds tended to be to the right of its track, thus slamming northern Dade and southern Broward counties.

Since that last intense storm hit Miami, both the city and its outlying areas have seen very large increases in population and exposures. If an event like the 1926 hurricane were to occur in south Florida now, RMS estimates the losses would reach almost $40 billion--$16 billion in commercial and $24 billion in residential.

That would be a nightmare scenario for the insurance and reinsurance industry, still reeling from the super-catastrophe of Sept. 11, with losses already estimated as high as $35 billion.

Estimated New Construction in Miami-Dade County, Florida

South Miami-Dade was designated the county's high-impact zone following
Hurricane Andrew. Estimates include construction from 1992 through 2001.

South Miami-Dade

New Residential Exposure   $3,095,273,681
 (Construction)
New Commercial Exposure      $305,492,393
 (Construction)

All Miami-Dade

New Residential Exposure  $12,891,843,085
 (Construction)
New Commercial Exposure    $3,069,654,106
 (Construction)

Source: International Hurricane Center, Florida International University
Insured Losses in Florida If Hurricane Andrew Hit Today

Catastrophe modeling shows how much greater the losses from Hurricane
Andrew would be today if the hurricane's path through Florida were
farther north. Each 0.1 degree euquals about 7 miles. A path 0.3 degree
north of Andrew's original location would create a direct hit on Miami.
The insured loss estimates are losses in today's dollars after
application of deductibles. They include residential, commercial and
industrial risks.

Landfall Location       Insured Loss in Florida
                             ($ Billions)

Andrew's original path           $20.3
Moved 0.1 degree north           $36.2
Moved 0.2 degree north           $46.7
Moved 0.3 degree north           $48.2
Moved 0.4 degree north           $46.3
Moved 0.5 degree north           $43.5

Source: Equecat

Note: Table made from bar graph

RELATED ARTICLE: Building a Better Building Code

For decades, South Florida has made serious efforts to reduce its hurricane vulnerability. Since 1957, Dade County, now Miami Dade County, has had one of the toughest building codes for high winds in the nation--a code that is credited with saving many lives during Hurricane Andrew in 1992.

The construction boom of the 1970s, coupled with complacency due to fewer hurricanes in the four decades preceding Andrew, led to an erosion in construction standards and code enforcement, said Risk Management Solutions, a leading catastrophe modeler.

After Andrew highlighted weaknesses in the code, local officials improved building regulations and enforcement, and demanded that builders use higher-quality materials and better construction techniques. Consequently, there have now been considerable improvements in the quality of newer construction, with tougher standards for walls, roofs, windows and shutters adopted in South Florida as early as 1994. Due to these changes, buildings constructed since 1994 are expected to have lower wind vulnerability than older structures. A new unified statewide building code, which went into effect in March 2002, has more stringent wind design and protection requirements and is expected to help reduce building vulnerability to hurricanes across the state.

A timeline of Florida's construction code history:

1926

A disastrous hurricane strikes Florida's greater Miami area, leading to the adoption of construction standards.

1974

Florida adopts statewide minimum standards for construction.

1957

Adoption of the South Florida Building Code in Dade County. The code originated with the Uniform Building Code of the International Conference of Building Officials.

1970s-1990s

Florida experiences a building boom. Nearly 70% of buildings in Broward and Palm Beach counties are erected between 1970 and 1992.

1992

Andrew, a Category 4 hurricane with gusts up to 175 mph, devastates South Florida, exposing weaknesses in the building code and construction industry. A survey by the Sun-Sentinel showed that nearly all the homes inspected that had construction flaws were built between 1975 and 1992, during the peak of South Florida's residential growth. A survey conducted to identify code violations and construction deficiencies concluded that the majority of failures were attributed to noncompliance with the prescriptive requirements of the area building code.

1994

The code used in Broward and Miami-Dade counties adopts tougher standards for walls, roofs, windows and shutters.

1996

The Florida Building Code Commission is formed to evaluate the existing system and recommend ways to improve it. In 1997, it concluded that the state needed a single code.

1998

The commission adopts Standard Building Code as a base rulebook and sets out to define a uniform building code for Florida.

2002

The new unified building code goes into effect.

Since Andrew, South Florida's most effective mitigation effort has been an overhaul of construction standards. Counties have instituted strict testing and approval for all building products, so materials are more likely to withstand hurricane-force winds and other pressures. Contractors must follow stricter construction guidelines and install certain approved products on homes and businesses. Hurricane shutters must pass stringent impact and wind-stress tests.

Source: Risk Management Solutions

Public/Private Effort Provides Florida Hurricane Insurance

About $919.3 billion in Florida residential property was insured by some form of policy that includes hurricane coverage as of June 30, 2001, according to reports filed with the Florida Hurricane Catastrophe Fund. That figure increased from $862.6 billion in mid-2000.

About 30% of the residential insurance exposure written in the entire state of Florida is on property in the southeastern sector, reports the Florida Insurance Council. Of this, 29% is written in Miami-Dade, Broward and Palm Beach counties.

The Cat Fund says 259 companies are writing various forms of residential insurance, including the Florida Windstorm Underwriting Association and Florida Residential Property & Casualty Joint Underwriting Association. This is down from 276 at the end of 2000.

The wind pool and the association are merging, effective July 1, to form the Citizens Property Insurance Corp., which will qualify for a federal tax exemption. The JUA peaked at 937,000 policies in late 1996. It reached a low of about 66,000 policies in summer 2001, but has grown again partly due to reductions by private carriers after the moratorium on nonrenewals expired last year. The JUA covered 110,705 properties as of Jan. 31, 2002.

Florida has about 150 private reinsurers that help primary residential insurers in meeting their Cat Fund deductibles and anticipated catastrophe losses above the Cat Fund's claims-paying capacity, the council said. The Cat Fund, which requires each insurer in the state to pay premiums into it, provides catastrophe reinsurance to the insurers if losses exceed a predetermined retention level.

"Rates were fairly steady during the late 1990s and remained so until recently," the council said in its 2002 Florida Insurance FACT Book published on its Web site (www.flains.org). "Many of the larger carriers implemented modest rate increases during 2001 or early this year, citing increased projections of catastrophe losses and increased reinsurance costs."

Catastrophe reinsurance becomes more expensive and harder to get.

Rates for property catastrophe reinsurance have been rising since Sept. 11, but not to the stratospheric levels that many in the industry initially predicted.

The rates for U.S. treaty reinsurance have gone up an average 15% to 30% since the terrorist attacks, but some were anticipating numerous rate hikes of 100% and more, said Robert DeRose, managing senior financial analyst in the Global Financial Services division of A.M. Best Co.

What we're hearing is that the market believes this is sustainable going into the next renewal season," DeRose said. "I think 15% to 30% is certainly a substantial increase, but it's just not as euphoric as people have mentioned."

The destruction of the World Trade Center in New York is expected to be the largest insured event in history with loss estimates ranging from $30 billion to $35 billion. After Hurricane Andrew in 1992--the second-largest insured loss in history--property catastrophe reinsurance rates in Florida and the northeastern United States spiked immediately because of a shortage in capacity. Then, rates increased 20% to 70%. Andrew blasted across South Florida, leaving a legacy of $15.5 billion in insured losses to residential and commercial policyholders in Florida, Louisiana and Mississippi.

But that significant hike in property catastrophe rates lasted only a year or so, whereas the current increases, though more gradual in their buildup, are expected to hold for a longer period of time, DeRose said.

Douglas Weymouth, executive consultant, reinsurance, for Liberty Mutual Group, recalled that before Andrew hit, his company was buying $180 million worth of reinsurance coverage for property catastrophe, excess of $20 million, and the rate on line--the premium paid divided by the limit purchased--was 6.5%.

"That was 1992, and we were able to buy the full $180 million," he said. The market then was London-driven--London was the pre-eminent catastrophe writer and Bermuda really wasn't a factor, he said. Of the syndicates that Liberty Mutual dealt with then, a couple important leads remain on its program today, but a number have merged with others, Weymouth noted.

"Rating was essentially based on past experience and exposure, but back then about all the exposure information we had was premium by state and by line" along with rating aids such as the Ecra wind formula, he said.

In determining rates, supply and demand were probably as important as catastrophe modeling, which was "fairly crude" by today's standards because the modeling companies themselves were only just being established, Weymouth said.

In 1993, the year after Hurricane Andrew, Liberty Mutual attempted to buy $200 million worth of reinsurance coverage, excess of $50 million. "In spite of paying almost three times as much--a 16.7% rate on line even with the higher retentions--we were only able to buy $112 million worth of coverage. So there was a tremendous constriction," Weymouth said.

After Sept. 11, Liberty Mutual was able to buy the same corporate property catastrophe reinsurance program with as much limit as it had in 2001, but it paid about 30% more for it, he noted.

"Right now, we're buying about all the capacity the market has to offer at standard rates in terms of the amount we buy," he said, "but it's still available." In late April, Liberty Mutual was in the process of renewing its commercial property risk treaty, some workers' compensation risk treaties and its commercial property catastrophe treaty.

More Information Required

In another change after Sept. 11, reinsurers have been stepping up the due-diligence process, requiring significantly more input from cedents in order to underwrite these accounts.

"I'm uncomfortable with the fact that underwriters are asking for a lot more information much earlier in the game," said Richard W. Wright, senior vice president of Marsh USA Inc. at the 40th annual Risk and Information Management Society conference in April. "My reaction is they're asking for what they can get, not what they need."

Robert Hammesfahr, a member of Cozen O'Connor, said insurers have been approaching his law firm for advice on the increased rates and term restrictions that catastrophe reinsurers are quoting.

"Usually, when you place cat reinsurance, lawyers are not consulted," he said. "But lawyers are being consulted in this situation." Hammesfahr, who has more than 20 years of experience in litigating and counseling clients involved in excess liability, coverage and reinsurance cases, said clients are now seeking him out "when they realize that they can't get what they want and are surprised by the terms being offered" by reinsurers.

Catastrophe reinsurers seem to be showing more interest in better defining the terms, Hammesfahr said. "As a legal matter, many people are focusing now on exactly what is the process by which one establishes a claim, what are the procedures for payment of a claim, and they are clarifying some of the areas where there were industry understandings in the past," he said.

Traditionally, a reinsurance transaction has been viewed as "a gentleman's agreement," Hammesfahr said, noting that there's usually been much less documentation in a large reinsurance transaction compared with the documentation in a large corporate financing transaction. "That's because there are many understandings between professionals as to how reinsurance agreements should be interpreted," he said.

But he sees that changing now, "because catastrophic reinsurance is balance-sheet protection when there is a major loss. I think there is new, heightened concern about performance issues," he said.

Weymouth said he has noticed a significantly greater demand from underwriters for information on covers for individual property risks and on workers' compensation catastrophe. "They are looking for aggregate and location information on workers' compensation that nobody knew how to get prior to 9/11," he said.

New Capacity

On the heels of Hurricane Andrew, capital flowed into the Bermuda reinsurance market. Another surge has occurred after September's terrorist attacks.

Within weeks of Sept. 11, insurance broker Marsh & McLennan and Bermuda-based Renaissance Reinsurance each announced it would set up new reinsurers on the island in response to the industry's capacity shortage. MMC Capital, Marsh's private equity subsidiary, formed Axis Specialty and Renaissance started DaVinci Reinsurance.

Other companies surfaced in the ensuing months--Allied World Assurance, Endurance Specialty Insurance, Arch Reinsurance, Montpelier Reinsurance and Goshawk Reinsurance. New insurers were still cropping up in Bermuda in late January--Olympus Reinsurance and Queens Island Reinsurance are among the latest to set up shop.

These companies have come on the scene in a relatively short period. After Andrew struck in August 1992, only one new catastrophe reinsurer opened for Jan. 1, 1993, renewals, and some barely got started for the 1994 renewal season, said Joseph Brandon, chief executive officer of General Re Corp., to a Bermuda symposium in January.

The Bermuda start ups are "being very disciplined--they have to achieve an adequate return for their stakeholders," Hammesfahr said. But the inflow of capital into Bermuda and the reinsurance sector in general still hasn't offset the capital that was lost as a result of the terrorist attacks and the decline in the equity markets, he added.

For its part, Liberty Mutual made little use of the new markets this year, Weymouth said. "We think it's important for us to help support them to some extent, but of course we've got to take care of the markets that have supported us over the last 10 years as well," he said. Liberty Mutual's quoting markets include reinsurers in London, Bermuda and the United States. While the largest portion of its program is done in Bermuda, London still supplies a substantial share, Weymouth said.

Hammesfahr thinks that Sept. 11 could have an impact on market share among top reinsurers. Well before Andrew, Hurricane Betsy, a Category 5 storm that hit South Florida in 1965, had a profound impact on the reinsurance industry in terms of shifting the predominant players, he said. "The question now is whether or not there will be an equally profound shift in the reinsurance players of the world because of the World Trade Center," Hammesfahr said.