ANALYSIS - Insurers to Gain From Better Hurricane Risk Models
Date: 14-Jul-06
Country: UK
Author: Simon Challis
The makers of catastrophe modellers, which are used to gauge the impact of storms and therefore help to set the right prices for risk, endured a torrent of criticism after their predictions for the cost of a string of hurricanes in 2004 and 2005 turned out to be billions of dollars short.
Reinsurers' stocks have been a difficult sell ever since -- the Dow Jones US reinsurance index, for example, is down over 5 percent this year, while the S&P 500 index is still showing a gain -- even though reinsurers have been able to hedge their risk by massive price increases.
"There's no doubt the models have lost some credibility," said Rob Bredahl, President of Benfield Inc., the US unit of UK-listed reinsurance broker Benfield Group Ltd..
After two fraught years, risk modellers such as RMS, Applied Insurance Research and Eqecat, will be nervously hoping they have got it right for 2006.
Modellers took the biggest roasting from their clients, who pay millions of dollars for their wares, for failing to come close to accurately predicting the cost of Hurricane Katrina.
Their eventual range of estimates of the damage from the storm was startlingly wide, at between US$14 billion and US$60 billion. So far it has cost the industry about US$41 billion, making it the most expensive disaster in the industry's history.
"They got it wrong. But then we all got it wrong to some extent," said Juergen Graeber, an executive at Hannover Re. All the largest reinsurers had to hastily revise their claims estimates as the extent of the devastation became clear.
Some of the biggest sources of claims, such as flooding caused by the collapse of levees in New Orleans, which left parts of the city under feet of water for weeks, were never included in the models in the first place.
"The models made no claim to include these losses, but clearly their absence caused many problems for insurers and reinsurers trying to assess their total losses," said Robert Muir-Wood, chief research officer of leading modelling firm Risk Management Solutions.
VALUABLE DATA
But the string of record-breaking storms in the past two years has provided insurers and modellers alike with valuable insights into how factors that had previously attracted little attention could rapidly push up the costs.
These include how a surge in demand for builders and materials created by storms hitting an area in quick succession can drive up the cost of meeting claims.
In the case of Hurricane Katrina, they were hit with the additional cost of rioting, looting, mass evacuation and property contamination.
Muir-Wood said that these, among other factors, meant RMS's model underestimated the actual cost of major storm losses in 2004 and 2005 by between 20 percent and 40 percent.
RMS's new model estimates the potential bill for personal lines insurance, such as motor or residential property, for a major hurricane, which is predicted to occur on average once in every 100 years, is now around 40 percent higher than before, while commercial claims are now expected to be nearly double.
The impact of RMS's revised estimate of the average annual bill from hurricanes for insurers is even more drastic. It predicts that the average cost of personal lines claims will rise by about 75 percent, while the bill for commercial claims will more than double.
The new models have hit insurers' wallets before the first breath of wind is felt.
The cost to firms of buying reinsurance to cover risks in Florida that may be affected by hurricanes virtually doubled in the recent July 1 reinsurance renewals, when many annual US contracts were renegotiated, Benfield's Bredahl said.
But the big question for those in the industry is whether the new models will now be more accurate.
"Have the heavy revisions made to the cat models meant they've regained some of the credibility they lost? Yes they probably have," said Bredahl.
"I would
