Coping with catastrophe
Ten things agents and brokers can do to help clients obtain adequate cat coverage
When it comes to property catastrophe insurance coverage, many commercial clients are being forced to swallow a bitter pill in the form of steep prices, new limits on policies, higher deductibles and a shortage in the amount of coverage available to purchase. To help clients cope with new market dynamics, agents and brokers should understand the complex factors that led to this tough market and develop a plan to deal with the coverage crunch. Following are 10 steps agents and brokers can take to help clients obtain adequate protection in today’s tight catastrophe market.
Be aware of recent catastrophes and their impact on the industry.
Hurricanes have caused the largest amount of insured property losses throughout the insurance industry’s history. In 2004, hurricanes Charley, Frances, Ivan and Jeanne caused approximately $22.9 billion in insured losses. For the first time, the industry saw high loss accumulation from a series of hurricanes, rather than a single event.
Although 2004 was initially considered a solitary exception, 2005 — with Wilma, Katrina, and Rita causing an estimated $77 billion in insured losses — proved the risks of hurricanes needed to be re-evaluated. For example, Hurricane Katrina, one of the most destructive natural disasters to hit the United States, resulted in an estimated $40 billion to $60 billion in insured losses and defined a new category of catastrophe, known as the “super-cat” event.
Recognize that insurers are experiencing three new market pressures.
After seven hurricanes in 2004 and 2005 and the ever-present threat of a major earthquake, insurance companies have been forced to take a more conservative approach to assessing and underwriting catastrophe risks. Insurers not only suffered record losses in 2004 and 2005, they also must navigate a triple whammy of new market pressures:
a) Increased potential for catastrophe losses. Insurers use catastrophe models to help quantify the likelihood of a natural disaster, to estimate potential losses caused by such a catastrophe and to aid in pricing coverage for a particular account or portfolio. The existing models dramatically underestimated losses from Hurricane Katrina, so in some cases, significant modifications were made.
Today, the three main modeling companies, Risk Management Solutions, AIR Worldwide Corp., and Eqecat, have consulted with meteorological and seismological experts to reassess forecasts of future catastrophe activity. With regard to windstorms, many experts agree that the sea-surface temperatures in the Gulf and Atlantic Ocean are rising and may contribute to a greater frequency and severity of hurricanes that hit the United States
Hurricane Katrina revealed that storm surge — the rise in water levels and wave action that accompanies a hurricane — has the potential to be more powerful and destructive than previously thought. Today’s models have been recalibrated to take into account a greater potential for storm-surge damage.
Another factor contributing to the potential for increased losses is new information on loss amplification, the cascade of far more devastating consequences that follow the initial impact of a major catastrophe. For example, demand surge is a critical amplification factor resulting from the increased costs for building material and labor following a major catastrophe. Revised hurricane and earthquake models now incorporate loss amplification factors, including demand surge, in their loss computations.
Due to enhanced understanding of hazards, models are now calculating a dramatically higher potential for losses due to catastrophe risks.
b) Increased capital requirements.To maintain ratings with agencies, such as AM Best, Moody’s, and Standard & Poor’s, insurers must keep more cash in reserve to backup policies (in some cases as much as 50 percent more capital) or decrease their catastrophe exposure. Although there has been some infusion of capital through non-traditional insurance resources, such cat bonds and “sidecars,” the impact has been limited.
c) Increased reinsurance rates. Another factor contributing to the strain on insurance companies is increased reinsurance costs. Reinsurers covered more than half of the insured losses from Katrina, and as a result, their prices have increased as much as 200 percent. Price increases, along with higher retentions and deductibles, have diminished insurers’ ability to purchase coverage on the policies they write.
Be familiar with catastrophe models.
Generally speaking, catastrophe modeling for a property portfolio or individual account requires agents and brokers to have a good grasp of their clients’ businesses and the risks they want to insure, including:
- The exact address of each property at risk;
- Detailed characteristics of building structure
Those data points are fed through a model to calculate the potential damage a natural disaster would have on the property. The model uses the financial data regarding the building, such as replacement costs for the insured site, business interruption values and other expense exposures. That information along with insurance terms, such as deductibles, amount of coverage (limits), co-insurance and other provisions, allow the model to calculate a financial assessment of the probable maximum loss (PML), and the minimum required premium (MRP) for a particular account or portfolio.
Set appropriate client expectations in client strategy sessions.
Agents and brokers must establish appropriate expectations with clients regarding the marketplace. Companies are generally being asked to pay higher premiums for lower limits, while retaining more of the risk.
In the 2006 Council of Insurance Agent and Brokers survey, brokers and agents reported that windstorm premiums for coastal properties were up 300 to 500 percent. Deductibles increased by as much as 200 percent by location. Tapping into the resources of a wholesale broker can provide a much-needed “reality check” on market conditions and availability of options.
With expectations regarding price and terms confirmed, agents and brokers should hold strategy sessions with clients to determine what coverage they need– if they may feel comfortable (or shareholders may feel comfortable) bearing a higher level of risk — and to find out whether they have agreements with lenders regarding coverage requirements.
Many agents and brokers invite a wholesale broker to be involved in the strategic planning sessions with clients. That provides clients direct access to in-depth market expertise. It also allows the wholesaler to have a clearer understanding of the risks presented by the client, helping the wholesaler to find the “right” solution.
Develop accurate, detailed, thorough client submissions
Agents and brokers must know how to put together thorough submissions that insurers will seriously consider and underwrite. In short, carriers want more information, so clients must comprehensively assess exposures, collecting and preparing data to provide details regarding properties.
Underwriting departments are inundated with submissions. If key information is missing, an application is often set aside for weeks. Thorough applications that contain quality data have the advantage — by being considered ahead of others, and by producing more positive results.
Catastrophe models have built-in variables that enable certain assumptions to be drawn. In the past, if key data was not included, such as information on roof geometry, the model was programmed to make an average assumption about the level of risk. Today, with the amount of exposure on the line, insurers cannot afford to make mid-line assumptions that are incorrect. If key information is not provided, the carrier often will have the model default to the worst-case scenario, which makes an account and premium less attractive from an underwriting perspective. That also places the insured at a significant disadvantage.
Ultimately, the results will depend on the risk and the carrier, but less information generally means a more conservative approach. Generally the more accurate and detailed the submission, the more positive the impact on pricing, limits, terms and conditions.
Understand primary and secondary structural characteristics.
To obtain best results, agents and brokers should understand the primary and secondary risk characteristics that help the model to assess the vulnerability or resiliency of a structure.
Primary structural characteristics include factors such as years of construction; occupancy type (residential, office, retail or industrial); number of stories; and type of construction (wood, masonry, concrete, light metal, steel frame). Those elements are easily attainable yet can positively impact modeling results. For instance, knowing the years of construction allows an insurer to apply appropriate building codes.
Each carrier uses secondary characteristics a little differently. A wholesale broker can greatly assist in knowing what elements the different insurers apply.
In terms of secondary characteristics for wind, clients should report construction quality, wind-resistance rating, basement flood-protection (especially in flood zones), and roof construction (roof geometry, roof-to-wall fastening and foundation connections). This list of secondary characteristics is not comprehensive, but it provides a sampling of factors that can drive modeling performance.
In 2004, a large portion of hurricane losses were due to roof failure and entry of water. If an organization spends a relatively modest amount of money to improve roofs, they can reduce or prevent a huge amount of loss and significantly reduce premiums. For example, if a structure has appropriate roof anchoring, that alone can affect premiums by about 25 to 30 percent on an individual location.
Some secondary risk characteristics may get into the minutia of construction, such as the size of the screws/nails that affix the roof and how far apart they are separated, but those factors can make a big difference.
In some cases, secondary characteristics may require documentation to justify a credit. Clients may need to have an engineering report or building inspection performed to accurately assess, document and submit characteristics to an underwriter. The data quality provided can help to differentiate an account.
Help clients to accurately assess values.
For underwriting purposes, clients also must provide total property exposure, in the form of replacement costs for structures and contents, business interruption values and extra expense exposures.
The valuation of property and business interruption is one of the key challenges in today’s market, particularly because many carriers are using a “statement of value” clause that calls for maximum indemnification to be capped at no more than the reporting values on the latest “statement of values” on file. In some cases, penalties may be incurred if losses exceed reported values.
Most policies are written to insure a building in terms of its “replacement costs,” but most companies do not track property values that way. Values are often reflected as fixed assets, meaning the initial cost of construction or the initial purchase price of a building. An appraisal may be performed, but even a current market assessment does not adequately represent the costs to replace that structure.
Policies are also written to cover a certain level of business interruption (BI). Assessing BI values is complex. The value is typically calculated on old worksheets, called gross earnings worksheets, and is based on financial results during a 12-month period. The BI worksheets predominantly drive modeling results, despite the fact that a company may have significant business continuity planning (BCP) to mitigate BI losses from a catastrophe.
Only with that information will carriers recognize that mitigating potential BI risks is just as important as mitigating potential property damage. If clients practice a “culture of disclosure” by continuing to quantify and disclose BI values and BCP efforts, a similar dynamic may evolve, allowing insurers to provide credits for sophisticated BCP efforts.
Access the global insurance community for best coverage options
To help navigate the complex catastrophe market, agents and brokers should consider working with a wholesale insurance broker that has access to the “global” property catastrophe insurance market. Wholesalers that are specialized in this area have strong relationships with dozens of carriers domestically and internationally that write coverage for coastal windstorm exposure, difference in conditions (DIC)/earthquake and excess flood.
In the future, many commercial clients will require a layered insurance program. Wholesalers can help by tailoring the layered program to individual risk exposures and by using multiple carriers to build the appropriate capacity and provide account stability over time. Some wholesalers will interact with the underwriters to discuss placement details and ensure best terms that optimize indemnification.
Wholesalers also can help agents and brokers stay abreast of carrier and coverage options. For example, agents and brokers must understand the long-term stability of carriers in both the standard and excess and surplus markets.
Is the carrier a new player? Do they have experienced catastrophe underwriting and claims staff on hand? When the 2004-2005 hurricanes hit, did the company pull out of the catastrophe market, or was it committed to providing coverage through tough times? Have the ratings changed through the 2004-2005 catastrophes?
Those are important questions agents and brokers should be prepared to address with clients, and wholesalers can be a valuable resource.
With high premiums or no other coverage available, some clients may need to consider government pools. The wind pools in the Carolinas, Florida, Mississippi, Louisiana and Texas can provide an affordable option with lower deductibles, but clients should beware of larger pools. Although large pools may be affordable, there may be risks involved. For instance, there is some question as to whether large state pools are financially sound and have the adequate capital to fully indemnify the policies should a major catastrophe occur. As a result, large pools should be considered the option of last resort.
Clearly address coverage exclusions.
Agents and brokers must help clients understand policy exclusions, such as flood, which was a huge point of contention with Hurricane Katrina. Flood presents a huge area of misunderstanding. While the policy language is explicit, many policyholders may not realize that storm surge from a hurricane is considered a flood event. Even when a commercial client has flood protection, it will generally only cover flood damage, not business interruption or temporary relocation expenses. To avoid errors and emissions lawsuits, agents and brokers should understand coverage exclusions and communicate them clearly to clients.
Present a “positive” outlook for coping with future catastrophe.
The prospect of a catastrophe does not have to be all doom-and-gloom. The insurance industry is uniquely positioned to play a leadership role in advancing forward-thinking solutions that will minimize the affect of future catastrophes. Although the structural changes are here to stay and will continue to impact capacity and pricing in the future, the more agents and brokers understand and adapt to these dynamics, the better they can position their clients to obtain coverage in today’s limited-capacity, highly competitive market. Understanding also will assist agents in helping their clients to mitigate exposures so that they can be more resilient when an event occurs, as well as suffer comparatively fewer losses than companies that are unprepared.
Ben Beazley is the CEO of Chartwell Independent Insurance Brokers LLC, headquartered in Los Angeles. He has more than 20 years of brokering experience. Web site: www.chartwell.us. Information for this article was gleaned from the “Coping with Catastrophe Risks” Symposium held in Nov. 2006, and represents perspectives from panelists Chartwell Independent Insurance Brokers, Insurance Risk Insurers, Glencairn Insurance Brokers, Axis Insurance, Swiss Re, Endurance, R.S.U.I. and Dempsey, Myers & Co.