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Are more Katrinas on the Horizon? The devastation wrought by hurricanes Katrina and Rita will bring higher insurance rates. But longer-term, insurers need to better understand and address the rising risks many believe are being amplified by climate change.

Perhaps it was prophetic: the fall meeting of the National Association of Insurance Commissioners (NAIC) was scheduled for Sept. 10-11 this year in New Orleans. Needless to say, it was canceled.


Hurricane Katrina's mind-numbing devastation in the Crescent City came as the NAIC, a collection of state insurance chiefs, has been thinking about the increasing risks to insurers from natural forces like hurricanes, drought and lightning. In effect, the commissioners are elevating climate change--that elusive and complex set of forces--to the forefront of issues they believe that insurers must come to grips with in the years ahead.

"If insurers are engaged on this issue, and I think they can be, there will be a significant change in their approach to climate change," said Joel Ario, Oregon's insurance administrator, in a September teleconference about the issue. "They need to be fully engaged in collecting data and projecting potential losses."

Tim Wagner, Nebraska Department of Insurance director and chair of the NAIC's Property and Casualty Committee, notes that more than hurricanes are at issue. There have been record droughts in the West and Midwest, he notes, and while central Europe experienced floods recently, there were fires in Portugal. "While the insurance industry is well-capitalized now, it's clear that we need to focus on financing risk [management] for these events," he says.

This is a paramount issue for insurers and their reinsurance partners, of course; estimates by October for insured losses from Katrina alone were running at between $40 billion and $60 billion, which would make it the biggest insurance catastrophe of all time. But as the losses ripple through the insurance world, they will surely impact corporate policies as well. Indeed, a report by Moody's Investor Service Inc. in late September concluded that corporate insurance rates would rise back to 2003 levels, or higher; they had declined for two years.

Vincent Vitkowsky, a partner in the Insurance and Reinsurance Department with law firm Edwards & Angell, notes that dozens of lines of business can be implicated in a major catastrophe like Katrina, running from business interruption to cyber-risk.

The most likely candidates for steep increases, not surprisingly: energy companies in the affected areas, with their production facilities and refineries battered by the storms. Annual premiums could be jacked up anywhere from 20 to 50 percent for these companies as the insurers try to recover their losses, experts say.

In the weeks after Katrina and Hurricane Rita, which walloped the oil and gas industry in the Gulf of Mexico, evidence emerged that insurers were or will be raising rates in some businesses and regions. American International Group Inc. (AIG), for instance, reported rate increases in businesses including property and marine insurance in some parts of the country. "There's some anticipation that may spread to other businesses, but we haven't seen that yet," Martin Sullivan, AIG's CEO, said at the end of September.

At HCC Insurance Holdings Inc., a Houston-based insurer with large exposure to energy and major commercial properties, CEO Stephen L. Way said that "from an insurance standpoint, premium rates will need to rise significantly in these lines of business to reflect both the increased frequency and severity of catastrophic events that have occurred over the past five years."

Some insurance experts observe that premium hikes for business lines could be steeper than those for homeowners, given that those corporate rates are less regulated and more subject to market forces.

Business interruption coverage is a major line affected by the storms. It covers loss of income from fire, flood or other interruptions ("perils"), and pays the expenses needed to keep a firm open and put it in the condition it would have been in were there no such loss. Ordinarily, coverage is based on either gross earnings or net income.

Yet, Roderick P. Thaler, executive vice president and national director for insurance broker Willis, thinks rate hikes will be limited. Pricing levels are near historic highs, he notes, as are deductibles; as a result, "the need for correction is much less than it was after 9/11."

With the high deductibles, much of loss will be absorbed by the insured companies. "We could see increases of 15 to 25 percent [in some commercial lines], but some will be much lower, maybe 5 to 10 percent," Thaler says. Any increases "will be meaningful and purposeful, and far more selective."

Bermuda-based reinsurers have said Hurricane Katrina will wipe out a full year's profit for the industry and questioned the ability of disaster modelers to estimate insured losses. PartnerRe Ltd. CEO Patrick Thiele says the reinsurance industry, with $160 billion in capital, could easily withstand a loss of $19 billion to $21 billion, which would be about 12 percent of capital, or "a full year's worth of earnings."

But will the losses actually reach $60 billion? "They really don't know," says XL Capital Ltd. CEO Henry Keeling. "The disaster modelers are all struggling with the numbers, and you've got to pick your poison."

"The models where there has been the most variance are really on the personal lines, and softer occupancy categories," like retail shopping malls, says Thaler. "The models do need to be examined, but they give terrific value in terms of looking at incremental changes year over year." However, models "can be used in a much more proactive way," he believes. More sophisticated individual insurers can look at a location, like a large plant, and see the impact of underwriting that risk on their overall risk profile.

The burgeoning losses from the hurricanes bring the specter of a ratings reassessment--and possible downgrades--for the hardest-hit insurers. Fitch, for instance, has maintained a stable outlook on the property and casualty industry, but that risk profile could change, the rating agency said in a statement.

"Catastrophe models may not be providing a complete, prospective view of the true, underlying risk of loss facing insurers for large or unusual events," Fitch said in a statement. Losses caused by floods, looting, fires, long-term business interruptions or liability may not be fully captured by the models, Fitch said.

While devastating storms like Katrina are the rare events that dominate headlines, the cumulative risk from smaller events may actually be greater, says Dr. Evan Mills, staff scientist at the U.S. Department of Energy's Lawrence Berkeley National Laboratory and lead author of a recent report on climate change and insurance. Phenomena like lightning strikes and flooding create larger annual insurance losses, in the aggregate, than one or two major storms, he says, and those lesser events are projected to increase more than 50 percent "under even very modest climate change," Mills says.

Some argue that global warming isn't the issue, per se--it's a function of cyclical, "natural variations" in seawater temperatures that can be tracked back a century or more. The warmer the sea water, the more numerous and severe the hurricanes.

Yet meteorologists report a striking 80 percent rise worldwide in the number of the most powerful tropical cyclones during the past 35 years, compared to earlier periods. Another independent study found a similar intensification in the Atlantic and western North Pacific. At the same time, the tropical oceans have been warming, a phenomenon driven, most researchers agree, by rising greenhouse gases, Science magazine says. Nature magazine suggests that the intensity--though not the frequency--of tropical cyclones is rising sharply, perhaps as a result of global warming.

"The available scientific evidence indicates that it is likely that global warming will make--and possibly already is making--those hurricanes that form more destructive than they otherwise would have been," notes an analysis by scientists at

More apocalyptic warnings relate to the possibility of a rise in sea-water levels as a result of global warming--an event obviously some time in the future. A study by the Federal Emergency Management Administration concluded that a one-foot rise in sea-water levels would increase flood damage in the U.S. by 36 to 58 percent.

Mills notes that insurance exposure is much higher than now than it was in the past, and that of the $1.8 trillion in collective losses since 1980, 90 percent have been weather-related. However, he says that those figures underestimate the losses, since smaller events are often not counted in data tabulations.

More alarming, the rate of increase in insurance losses has been eight-fold since the 1960s, Mills says, and total insured losses have been growing 17-fold, since people are buying more insurance. Further, the variability of these losses has been increasing, making it harder to price and manage risks. "They are constantly redefining the terms of maximum possible losses," Mills says, and given that existing data is "very limited," insurers are "flying partially blind."

Some insurance industry groups are indeed thinking about these warnings. The Association of British Insurers, for instance, released a report this past summer that predicted losses from windstorms (including hurricanes) in the U.S., Europe and Japan rising by 60 percent in coming decades. In fact, it noted that models show that insured losses from "extreme" storms could approach a staggering $150 billion.

Others are considering more pragmatic solutions to risk management. Nebraska insurance commissioner Wagner, for instance, urges the creation of tax-deductible reserves that can be pre-funded by insurers and drawn on as warranted.

But there seems to be a consensus that the insurance industry can't just throw its collective hands in the air in the face of rising storm-related risk and bemoan the unpredictability of nature. "We need a lot more engagement from the insurance community than has been shown to date," says Oregon commissioner Ario. "The reinsurers are more engaged, especially in Europe." Only half of the domestic U.S. reinsurance companies showed up for a conference on climate issues last year, he notes.

Says Mindy Lubber, president of Ceres, a national coalition of investors and environmental groups working with companies to address challenges such as climate change: "The issue is to move reasonably yet forcefully, in business-like ways."


* The devastation created by Hurricanes Katrina and Rita will cause a ripple effect on insurance rates for businesses as well as homeowners.

* Insurance commissioners have publicly called on the insurance industry to consider the impact of climate change in their risk models.

* Mounting evidence suggests that storms, especially tropical cyclones like the recent hurricanes, have been intensifying in severity in recent decades.

* There is widespread agreement from outside the insurance industry that risk models need improvement, and that insurers need to be more proactive.
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Title Annotation:insurance
Author:Marshall, Jeffrey
Publication:Financial Executive
Geographic Code:1USA
Date:Nov 1, 2005
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