Insurers see greater risk of hurricanes and charge more
Jun 1, 2008
Posted on Sun, Jun. 01, 2008
BY BEATRICE E. GARCIA AND EVAN S. BENN
Scientists disagree about whether global warming is promoting more hurricanes — but here’s an inconvenient truth:
As the 2008 storm season begins, the insurance industry isn’t waiting for consensus. It’s betting on more hurricanes and cutting back coverage and hiking premiums in Florida, where home insurance rates have jumped at least 100 percent — as much as 300 percent in some cases — over the past four years.
Spurred by a pronounced jump in the number of powerful storms in recent years, including the very active seasons of 2004 and 2005, insurers have changed the ”risk models” they use, and the new versions expect more hurricanes.
”We can’t wait. We just know it’s going to be bad, and we price off that view,” said Steve E. Smith, president of property solutions for ReAdvisory/Carvill America, a Chicago-based reinsurance broker that works with insurance companies.
Specifically, the new models — sophisticated equations into which experts feed various data such as storm frequencies, wind speeds, overall weather patterns, terrain and population densities — focus on data from just the past several years. They exclude data from prior years, in which storms were less frequent.
One such short-term model, introduced in 2006, focused on storm activity since 1995, and yielded loss estimates 40 percent higher than those from a model that went back to 1900.
Florida regulators have not yet approved the use of short-term risk models by insurance companies for setting their rates. But reinsurance companies — which sell backup coverage to insurance firms — are already using them to set the rates they charge insurers.
The result? Higher reinsurance costs that are passed along to homeowners like Stan Medow.
After 18 years — and after paying for a new roof for Medow’s Hollywood home after Hurricane Wilma — Liberty Mutual is dropping his policy. A new policy with Citizens Property Insurance, the state-run company, could cost about $5,000, about 35 percent more than he has been paying. He could keep his premium at the same level, but he would have to accept less coverage.
”When times are good, insurers like to write policies and make money,” Medow said. “But when they have to pay out a lot of money, they get a little agitated. Loyalty doesn’t mean anything anymore.”
On top of charging higher rates, insurers are asking homeowners to take on more risk. Policyholders can forgo replacement coverage on furniture and clothing or choose a higher deductible — perhaps as much as 10 percent of a home’s insured value.
And the market is only getting tighter. State Farm, the largest private insurer in Florida, stopped writing new policies in the state in February. Allstate, which has limited the number of new policies it writes along the Atlantic and Gulf coasts, has pared about 65 percent of the policies it held in 2005. It has about 250,000 policies now in Florida.
Many companies simply won’t write policies for homes built before 2002, figuring that the newer ones meet a stronger building code and can better withstand a big hurricane.
One major factor driving insurers’ storm-damage estimates higher is the growth of waterfront development in South Florida and throughout the state over the past several years. Some experts have estimated that a Category 5 hurricane in South Florida could cause $140 billion in damage.
”The 1970s-’80s were anomalously quiet years, during which much coastal development occurred in the U.S. We are now paying the price for this,” said Kerry Emanuel, a hurricane meteorologist at the Massachusetts Institute of Technology.
But gauging other factors — including hurricane frequency — is somewhat more subtle. Scientists agree that there have been more hurricanes in recent years, but they don’t agree on why.
Emanuel supports the global warming-hurricane link.
”There is no disagreement among anyone in my profession that there has been a substantial increase in activity in the North Atlantic over the last 10 to 15 years,” Emanuel said. “This alone could justify increased premiums.”
”We know storms get their energy from warm water,” said Lisa Moore, a scientist with the climate and air program at the Environmental Defense Fund in Washington, D.C. ”It would be fairly prudent for insurance companies to factor in global warming” into their loss projections.
But the other camp says that global warming, while a valid environmental concern, is not causing more hurricanes. These scientists attribute the recent uptick to natural climate cycles that span decades.
Tom Knutson, a research meteorologist with the National Oceanic and Atmospheric Administration’s fluid dynamics lab in Princeton, N.J., concluded in a study last month that global warming is not causing more hurricanes.
”Our interpretation is that, yes, we are in an enhanced period, but it’s not terribly unusual by historical standards, and we don’t expect a strong increasing trend in tropical storm or hurricane numbers due to greenhouse gases,” Knutson told The Miami Herald.
His paper — based on a long-range computer model — predicted fewer but more powerful hurricanes by the end of this century.
Still, he warned that the decrease likely won’t be noticed for several decades — and that’s what has insurers concerned.
‘The real question is, `What do you expect for the next five years?’ ” said Bob Ward, director of public policy at Risk Management Solutions, a risk-modeling firm.
Ward’s company, one of four private firms that develop the models used by insurers and reinsurers, introduced a new one in 2006 that broke with the research norm by putting greater emphasis on storm activity since 1995.
The new model came partly because the firm’s clients asked for a way to respond to the storms of 2004 and 2005, Ward said.
Today, all the risk-modeling companies provide clients with both short-term and long-term views of possible hurricane losses.
One of them, Boston-based AIR Worldwide, developed a catastrophe model that focuses on recent hurricane activity, how it correlated with warmer sea-surface temperatures in the Atlantic Basin, and how both related to storms making landfall.
Under warmer sea-surface temperatures, the company’s research showed that the southeast coast, from Cape Hatteras to the Florida Keys, would get more intense storms — Category 3 to 5 — especially along the Carolinas’ coast. The region from the Keys through the Texas Gulf Coast would see more storms, but weaker ones — Category 1 and 2 hurricanes.
Peter Dailey, AIR’s director of research in atmospheric science, said the warm sea-surface temp model yielded losses about 15 percent higher than those generated by the firm’s longer-term model.
TAKING LONGER VIEW
Florida has so far prohibited insurers from using the shorter term to help set premiums; only longer-term models are accepted by the Florida Commission on Hurricane Loss Projection Methodology, the state panel in charge of reviewing the computer models each year.
”We encourage innovation. But we haven’t seen the scientific evidence to support the short-term pricing models,” said Randy E. Dumm, the panel’s current chair and associate professor of risk and insurance at the College of Business at Florida State University. Florida is the only state that requires this sort of approval process.
But the commission’s scrutiny may be less than meets the eye. Reinsurers are already basing their rates on the shorter-term models — leading to higher costs for the insurance companies they serve.
Insurance companies buy reinsurance to cover part of the losses they might face in a particular year, allowing them to put aside fewer dollars as surplus to cover claims. An insurer might cover anywhere from 50 percent to 90 percent of claims with reinsurance.
And when reinsurance costs more, insurers pass those costs along to their policyholders — so consumers in Florida are still hit with rates based on higher loss estimates.
”How we use the models doesn’t matter as much as how the reinsurers use them,” said John Auer, president of American Strategic Insurance in St. Petersburg, the largest insurer based in Florida. “That’s going to impact our costs.”
Regardless of the fine points, there is little doubt that insurers are concerned about the effects of climate change — not just on hurricanes, but on disasters ranging from wildfires to droughts to winter storms.
In a recent study, Ernst & Young, the accounting firm, concluded that climate change is the ”greatest strategic threat facing the insurance industry” this year. The National Association of Insurance Commissioners has a task force studying climate change.
And some argue that the insurance industry can and should do more to address the issue than simply raising rates and canceling coverage.
”The industry response has been reactive so far,” said Andrew Logan, insurance program director for the Ceres Group, a think tank funded by institutional investors.
His suggestions: Provide credits for drivers of hybrid cars and owners of green buildings. Encourage drivers to drive less by pricing car insurance by the mile, which is already done in Europe.
”Insurers need to be proactive rather than fleeing at the first sight of risk they don’t understand,” he said.
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