Here Comes The Rain Again: Insurers Prepare For Tougher Hurricane Seasons
as posted at www2.standardandpoors.comby Amy Friedman
For the insurance industry, the 2005 U.S. hurricane season—especially Hurricane Katrina and its aftermath—was unprecedented. The season was the longest, most volatile, and most costly to the industry on record, generating 28 storms with sufficient vigor to warrant naming. Indeed, for the first time ever, the Greek alphabet, through the letter zeta, had to be called into service. The hurricanes exposed weaknesses, not just in the levee systems but also in the models used to price coverage.
Dennis, Ophelia, Katrina, Rita, and Wilma—2005's five most destructive storms—accounted for $52.7 billion in insured losses in nine states, according to the Insurance Service Office. Of the five, Katrina, which made landfall on Aug. 29 as a Category 3 storm, was the most damaging. The wind and water damage, combined with shortfalls in underwriting and modeling, precipitated more than $40 billion in insured losses, which is even more than the losses that resulted from the World Trade Center's destruction in 2001.
Rita and Wilma, which both followed Katrina, were no slouches in the destruction department, either. Rita, Category 3, slammed into the Gulf on Sept. 24, 2005, just west of where Katrina hit, generating $4.7 billion in insured losses in eastern Texas and western Louisiana. Wilma, which hit on Oct. 24, came ashore in South Florida as a Category 3 as well and was the second most powerful hurricane on record ever to hit the state. Battering the same region that was hit by 2004's quartet of Category 3 and 4 hurricanes, according to the most recent estimates from Florida's Office of Insurance Regulation, Wilma caused more than $9.3 billion in insured losses, nearly half the $21.6 billion generated from 2004's Florida hurricanes.
More Frequent Major Losses Must Be Factored In
Despite these high loss estimates, the 2005 season has not and is not expected to exert severe pressure on industry ratings (see "Increases In Hurricane Loss Estimates To Have Little Impact On Insurer Ratings, published Jan. 23, 2006, on Ratings Direct). However, last year's hurricanes did reveal shortcomings, not just in the models but also in the companies' use of those models. Insurers and modeling companies have been forced to rethink severity (loss size) and frequency. Major hurricanes (Category 3 or higher) were previously modeled as infrequent events, but it is clear that such storms are now far more common and severe, so higher and more numerous expected losses must now be taken into account.
As insurers are still developing their understanding of frequency, severity, demand surge, and storm surge, Standard & Poor's Ratings Services believes the way they manage hurricane risk will evolve for years to come.
Buttressing Risk Management
After every destructive major (Category 3 or higher) hurricane that has hit U.S. soil, insurance companies have sought to further improve their risk-management capabilities through a variety of means, including tightening underwriting, firming pricing, segmenting risk, and reducing exposure. It happened in 1992 after Hurricane Andrew hit South Florida, it happened in 2004 after the quartet of hurricanes that battered the southeast U.S., and it is happening now.
For personal lines companies, 2005 losses were less severe than anticipated. Original estimates predicted, at minimum, that three or more quarters of earnings would be lost, but the actual losses were more in the two quarters' range. Although losses were still substantial, companies' strong capitalization enabled them to absorb the hits comparatively easily. For example, State Farm's 2005 earnings of $3.2 billion were down 39% from 2004's $5.3 billion, and Allstate's earnings of $1.77 billion were down 45% from 2004's $3.18 billion, but the ratings on both groups were affirmed (though the outlook on Allstate was revised to negative).
However, to buttress their risk management, personal lines companies are reducing their exposure to coastal areas. The national companies—Allstate, State Farm, and Nationwide, among others—separated out their Florida risk after 1992's Hurricane Andrew and are now looking at restricting their coastal exposure more generally. Nationwide also plans to drop 35,000 Florida customers in March when their policies expire. Allstate, which has written no new coverage in Florida since 2004, plans to stop covering 95,000 Florida homeowners and is scaling back its exposure substantially in coastal areas of downstate New York and New England, which could affect at least 50,000 insureds in New York, where Allstate has a 26% market share.
Other carriers, including some smaller personal lines insurers, are following Allstate's lead in withdrawing from coastal homeowners coverage. This will increase the exposure and volatility of the various state insurers of last resort.
Reinsurers Will Feel The Pain
On the commercial lines side, losses were substantial, but most primary carriers' storm losses were one to two quarters' earnings. Capital was also not adversely affected. The insured losses were weathered by risk-sharing with reinsurers and, in some cases, accessing capital markets. Standard & Poor's outlook on the sector remains stable (see "U.S. Insurer Failures Continue Record Lows," published Feb. 13, 2006, on RatingsDirect).Reinsurers tend to have smaller balance sheets and, in some cases, more concentrated income streams than primary companies, resulting in greater earnings and capital volatility. As a result, they will most likely bear the brunt of insured losses. As hurricane-related claims continue to roll in, Swiss Re's 2005 profit of $1.11 billion was down 41% from 2004's $2.17 billion, giving the company its worst year since 2002. Bermuda-based PXRE Reinsurance Co. and its related credits has thus far endured a two-notch downgrade on Feb. 23, 2006, and the ratings remain on CreditWatch negative, where they were placed on Feb. 16, 2006, because of developments in the company's business stemming from 2005 hurricane losses. Other reinsurers are also seeing significant losses.
On the pricing side, although substantial increases for all lines—personal, commercial, and reinsurance—have been realized, the market did not harden as much as Standard & Poor's believes might be needed. Unlike the nationwide rate increases seen after the World Trade Center's destruction in 2001, current rate increases are concentrated in coastal regions, especially in the Gulf of Mexico area, and are focused on property lines.
Rate increases still are occurring and in some cases are quite high. On the commercial side, rates for specialty coverage, such as boats and offshore energy, are seeing big rises, with some insurers charging and getting increases of more than 100% on renewals. Business interruption insurance for certain classes of insureds is also seeing 50%-100% rate increases.
Overall, reinsurance premiums for property catastrophe coverage are slated to rise about 50%-100% in the U.S. Gulf region, while other areas of the country will experience 0%-20% increases. For smaller primary insurers, which depend heavily on reinsurance for their risk mitigation, reinsurance costs might be increasing 100% or more. These sizable hikes, however, are still inadequate, which is driving some reinsurers to pull out of particular markets and certain types of accounts.
Spotlight: Affected States
Personal lines increases are highest in Louisiana, Mississippi, and Florida, the three states most affected by 2005's hurricanes. Each is taking substantial steps to cope.
Louisiana
Hurricane-related claims in the state were a record $12.4 billion in 2005. Louisiana homeowners, especially those in coastal areas, will be enduring harsh rate increases—if they can get coverage at all. Insurers are either pulling out of the state entirely or restricting coverage to inland areas. As a result, more homeowners will need to get coverage from Louisiana Citizens Property Insurance Corp., which, similar to Citizens Property Insurance Corp. in Florida, is the insurer of last resort. Its premiums are typically among the highest in the state and will most likely increase.
Louisiana's catastrophe pool, launched in 2004, raised only $100 million when Katrina came through and had $340 million in reinsurance coverage. To replenish the pool, Louisiana homeowners will be hit with substantial increases, including a 15% increase in 2006 property coverage to replenish the catastrophe fund, an emergency premium of up to 20% of current rates for up to 25 years to pay off the $1.4 billion bond Citizens recently issued, and rate increases from insurers.
Mississippi
Hurricane insurance claims in Mississippi in 2005 were $5.5 billion, primarily from Hurricanes Katrina and Rita. Mississippi's insurance pool carries $175 million of reinsurance, and private property insurers doing business in the state have been assessed $285 million to replenish the pool. Unlike Florida's and Louisiana's pools, Mississippi's covers only wind and hail damage. The State Senate's Insurance Committee is expected to add contents and living expenses to coverage, which will lead to price increases.
Personal lines insurers are also reevaluating their Mississippi exposure, especially in the state's six coastal counties, as Mississippi has long been an unprofitable homeowners' market. The beneficiary will likely be the Mississippi Windstorm Underwriting Assoc., the state's insurer of last resort.
In December, Insurance Commissioner George Dale established the Mississippi Mediation Program, which is based on a similar program Florida successfully implemented in 2004. The program is available only to claimants who have not filed legal actions and does not apply to commercial insurance claims, private passenger motor vehicle insurance, liability coverage contained in property insurance policies or to National Flood Insurance Program policies. Decisions are nonbinding.
At least two lawsuits have been filed that seek payments for flood damage under homeowners policies on the grounds that the initial damage was caused by wind, not flood. If successful, these suits could have a significant effect on the insurance industry nationwide as well as on the national system of flood insurance.
Florida
Despite charging the highest premiums in the state, Citizens Property Insurance Corp., Florida's insurer of last resort, has run up $1.36 billion in deficits after two straight years of paying for damage from devastating hurricanes. It is currently seeking a 62% rate hike from its 796,000 customers.
The state-run Florida Hurricane Catastrophe Fund reinsurance program was hit hard in 2004 and 2005. It expects to pay out a total of $3.85 billion for the season, which includes $2.85 for Wilma alone. The fund does have the authority to create up to $15 billion in additional emergency capacity, if needed, or can do an emergency assessment of Florida insurance policies of up to 6%.
On Feb. 13, Florida's House Insurance Committee Chairman Dennis Ross introduced a bill that would split Citizens Property Insurance Corp. into two, with one part for primary residences and one for other property types, which would be required to bear more financial responsibility. Citizens would also be forbidden to insure homes worth $1 million or more.
To refurbish the catastrophe fund, the bill would also allow residential property insurers to charge consumers an additional 10% statewide to cover any assessment and would permit them to raise rates up to 25% in specific areas without regulator approval (up from 15%). In addition, it would launch a $100 million endowment that would offer no-interest loans for hurricane-proofing homes.
Looking ahead, insurers have good reason to continue their patterns of caution because populations are increasing in coastal areas. At this point, according to the Population Reference Bureau in Washington, D.C., more than 50% of the U.S. population lives within 50 miles of a coast. Meteorologists are predicting another 10 to 20 years of heightened hurricane activity, with a major hurricane slated to have an 81% chance of making landfall along the Atlantic coastline this year. And with the next hurricane season due to launch on June 1, 2006, all of this constitutes growing exposure for property/casualty insurers, which makes the need for good, well-tuned enterprise risk management imperative.
United Policyholders is a non-profit organization founded in 1991 and dedicated to educating the public on insurance issues and consumer rights. UP publishes educational materials and serves as a resource for individual and business policyholders and residents of communities with insurance problems. UP’s Amicus Project provides information to courts of law to support policyholders’ legal rights. UP unites policyholders and their advocates by sharing information. Write to UP at 110 Pacific Ave., PMB 262, San Francisco, CA. 94111, call us at (510) 763-9740, or visit our website at www.unitedpolicyholders.org.
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