Lessons Learned from Hurricane Andrew

How the Insurance Industry Can Mitigate the Next Big Natural Disaster

As an industry, we knew there could be large and costly hurricanes. We witnessed the destruction that Category 5 Hugo wrought on the Carolinas in 1989. At the time, however, this $4 billion event, which doubled the previously-seen maximum insured loss for the industry, looked like a black swan. We might have considered it a test of the industry — and one which we passed given that only a dozen or so small regional carriers went under.

Fast forward three years to Aug. 24, 1992. For those of us in the natural catastrophe risk management field, the day Andrew struck Florida marked the birth of our profession. When the winds died down and the water receded from Florida and Louisiana, we were left with $15.5 billion of insurance claims, eight legally insolvent insurers, and several more technically insolvent subsidiaries which required bailouts from their parent companies.

Our industry and its regulators woke up to the risk, and tools came online to help us manage the risk more effectively. Twenty-five years later, Andrew’s damage has been dwarfed by Katrina, Sandy, Ike and Wilma. Because of the steps we took following the event, the industry was able to easily withstand these events and serve its intended purpose.

I began my journey in the insurance industry in 2003 quantifying damage and responding to regulators on the Gulf Coast following the tumultuous 2003 and 2004 seasons. I have spent most of my career managing natural and man-made catastrophes, including setting up formal catastrophe risk analytics departments at two leading commercial lines carriers.

As I scan the horizon of emerging risk, I find myself awestruck that we have so much information readily available to us and yet we still need a catastrophic event to wake us up to risk. Of particular concern to me is the risk posed by infectious disease events. If we use the past to help us learn about the future, as we are usually so good at doing, there are three primary lessons we can learn from the experience of Hurricane Andrew to build resilience to the inevitable pandemic equivalent:

• A big event is not required to take action.
• The insurance industry plays an important role in resiliency.
• Innovators will be rewarded.

A Big Event is Not Required

In 1992, we knew how to add up limits and use probable maximum loss (PML) approaches to estimating losses to potential events. Andrew gave us a tangible lesson that more sophisticated methods were required to adequately manage weather risk. Over the next 25 years, catastrophe risk models have grown in complexity and accuracy. Every major insurance company has a catastrophe risk management function which regularly quantifies the potential costs of weather events. Most do this at the point of underwriting and have built this into the way they price policies.

While every company has its own view of risk, all point to reference views of the major modeling vendors when quantifying risk for internal or regulatory purposes and when offloading risk to reinsurers and increasingly the capital markets. As a result, the market for offering, trading, and offloading hurricane risk is extremely liquid and efficient.

The life insurance equivalent to a hurricane or earthquake is a deadly epidemic or pandemic. According to the Gates foundation, a fast-moving airborne pathogen could kill more than 30 million people in less than a year, and there is a reasonable probability that type of event will occur in the next 10 to 15 years. In the United States alone, life insurance accounts for slightly more than 50 percent of the over $1 trillion in annual net premiums written.

We should take the lessons we have learned and skills we have collectively developed in managing property natural catastrophes and focus equal — if not greater — time and energy on managing natural catastrophe risk as it relates to the much larger life insurance industry. We don’t need to wait for an event to occur. The tools and models already exist, and we have a robust framework for understanding the risk.

Important Role in Resiliency

No insurance company can stop a hurricane, but collectively, we have made the world more resilient to these events by offering financial incentives for homeowners and businesses to appropriately build and prepare for the events. Most modern personal and commercial property policies offer discounts for things like storm shutters and up-to-date roofs. Similarly, for earthquakes, good luck finding affordable property insurance for a masonry building in an earthquake-prone zone like California. In taking steps like these, through our pricing algorithms, we play an important role in not only managing and pricing risk, but also educating our customers on measures they can employ to protect themselves and collectively make the world more resilient.

These same concepts hold for epidemic outbreaks. What is really exciting, though, is that unlike a hurricane, properly timed and placed insurance can actually stop an event from getting worse. Imagine an insurance mechanism that kicked in following a small regional outbreak. The funds from the insurance policy are used to fund preventative measures and to bring doctors and supplies in to help prevent a larger epidemic and ultimately a pandemic. Exactly these types of policies are currently being developed by the World Bank and Africa Risk Capacity with support and guidance from the reinsurance industry and technical partners.

Innovators Will Be Rewarded

It has been said that the insurance industry is good at managing risk, but not necessarily at taking it. It is through this lens which we might understand why technological adoption has been so slow in this space. If we again look back to post-Andrew at those companies — Renaissance Reinsurance comes to mind — those who embraced technology and came up with new ways of doing things were rewarded. Munich Re recently announced that they are setting up a dedicated infectious disease insurance business unit and others are beginning to further explore opportunities in the space. Who will join them as the innovative early movers in this space?

We are not always the fastest moving industry, but over the course of my career, I personally have witnessed dramatic shifts towards proactive and effective management of catastrophic risk on more than one occasion.

Thankfully the tools we need have already been developed and we can look to our catastrophe risk management departments as a guide for managing risk to infectious disease events.

Doing so will not only make our companies and our world more resilient, but will also provide a new vehicle for growth both for our existing customers and into new markets.