Hurricane Modelers Help Insurance Companies Determine Risk
by Wire Service
July 22,
2006
By Simon Challis
LONDON (Reuters) - Armed with reams of data
from the two worst U.S. hurricane seasons on record, risk
modeling firms have shaken up their models to uprate their
costs, which should make it third time lucky for insurers and
reinsurers.
The makers of catastrophe modelers, 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 U.S. 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
U.S. unit of UK-listed reinsurance broker Benfield Group Ltd..
After two fraught years, risk modelers such as
RMS, Applied Insurance Research and Eqecat, will be nervously
hoping they have got it right for 2006.
Modelers 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 $14
billion and $60 billion. So far it has cost the industry about
$41 billion, making it the most expensive disaster in the
industry's history.
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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 modeling firm Risk
Management Solutions.
VALUABLE DATA
But the string of record-breaking storms in the
past two years has provided insurers and modelers 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
U.S. 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 wouldn't say the market has reaffirmed its
faith in modeling, but it probably has more faith in them than it
had last October. It's no longer flavor of the month to go around
kicking cat models, like it was last October," said Muir-Wood.
