It may not have started with the vehement criticism logged by Sen. Trent Lott, R-Miss., and Rep. Gene Taylor, D-Miss., against Bloomington, Ill.-based State Farm over hurricane damages to their respective homes, but the negative press that's ensued in Katrina's aftermath is still haunting the insurance industry.Shortly after Lott's brother-in-law, high-profile plaintiff attorney Richard "Dickie" Scruggs, filed a federal lawsuit, however, a flurry of additional actions, some of which are being played out by state and federal regulators, thrust the P&C insurance industry into defense mode.
Those studying the popular press might say that in some ways Katrina created a different type of perfect storm. Lott's suit preceded class action litigation, cries of foul play concerning faulty science and inadequate loss payouts mixed with news of excessive renewal rates and P&C carriers making an abrupt exit from coastal areas. All of this activity has created a perception of bad business.
The public's perception aside, the question remains: In the face of growing risk management complexities, are carriers able to properly understand, analyze and manage catastrophic risk? State Farm, the most visible carrier in the recent press reports, defends its ability to comprehend catastrophic risk in coastal areas but admits it is "always learning."
"Some of the issues that have come out of the press, [such as] not knowing what our exposure was, I wouldn't say I agree with that," says Jeff McCarty, executive vice president of State Farm's P&C actuarial division. "There may have been some differences or change in terms of how you measure [risk]. Now that we know we are in a high-frequency hurricane period, it will be an evolving process."
A good example, says McCarty, is the theory that the industry is in a period of high hurricane frequency because of the sea surface temperatures' warmth.
"Granted, we've been in this period awhile, but that whole concept hasn't evolved until the last couple of years, so yes, there are some areas we don't have a good handle on but we are trying to learn from it and trying to develop that. It will be an evolving process, ever-changing," he says.
MODELS PLAY A ROLE
McCarty maintains that CAT models have already performed well for the company.
With an eye on identifying strengths and weaknesses in each model, State Farm, like many large carriers, employs data from all three major risk management service providers; Risk Management Solutions Inc., (RMS) Newark, Calif.; Eqecat, Oakland, Calif.; and Boston-based AIR Worldwide, and combines it with its own homegrown model.
"If there is any business that models were developed for, it would be State Farm's, because we have an extremely homogenous book of business," he says.
Quantifying insurers' and major corporations' exposure to natural catastrophic risk, the model makers are stepping up their consulting, data gathering and distribution efforts.
All three organizations collect historical P&C loss experience data as well as data on a host of environmental factors, including sea-surface temperatures, wind patterns and more. And although they may differ on their ratemaking benchmarks, all take into account 100+ years of available historical data.
Yet certain, specific scientific data alone is insufficient to explain the increase in hurricane activities, says Jayanta Guin, Ph.D., vice president of research and modeling at AIR.
"Even as we gather data from organizations such as the National Oceanic Atmosphere Association, the National Hurricane Center and beyond, we know that when we include new science, such as the influence of sea surface temperatures, we must be careful in how we incorporate that information because sea surface temps alone do not explain the increase [in hurricane activities] we've seen."
Research that followed Katrina included a new range of models to capture loss amplification effects that followed the largest catastrophes, points out Robert Muir-Wood, Ph.D., chief research officer at RMS.
"We have obtained approximately $25 billion of detailed claims data from our clients covering the 2004 and 2005 seasons, along with high resolution insured exposure data from which we have been able to refine all aspects of our wind vulnerability functions as well as to identify in great detail how to differentiate insurance categories," he says. "We now know, for example, where a carrier should be prioritizing its efforts in collecting better data."
Muir-Wood admits, however, that the work to bring climatologists together to define an appropriate, forward-looking perspective on hurricane activities brought with it a respect for the bigger picture.
"We recognized that it was no longer tenable simply to assume that historical averages alone offered the best representation of today's activities," Muir-Wood says.
AIR's Guin, agrees. "The typical practice of using historical data is never sufficient," he says. "This is why we build probabilistic models that generate thousands of scenarios. We are not forecasting; our models do not answer the question 'how many will occur.' Rather, our focus is on answering the question "what is the likelihood of any hurricanes, and what does that mean for the risk?'"
For many insurers, answering the "what does it mean" question elevates risk management to the next level, taking into account other important factors, such as claim volume levels and loss mitigation efforts.
Thomas Larsen, senior vice-president of product management at Eqecat, a wholly owned subsidiary of ABS Group, maintains that carriers that apply a true enterprise risk management (ERM) approach to their CAT risk may have an advantage.
"You need to understand the overall volume of your claims risk, how many people will be filing claims after a catastrophe and what the value of those claims will be," he says. "More carriers are not just using CAT-specific models-they are looking at the full cycle and then managing their business toward that."
BROADER APPROACH NEEDED
Karen Pauli, senior analyst with TowerGroup, a Needham, Mass., research firm, says carriers need to think in even broader terms.
"ERM manages all exposures within a company, not just your homeowners book," she says. "So having an enterprisewide risk management strategy and having ownership from the top down is key, because when you experience an event the size of Katrina, it truly does affect the entire organization."
State Farm's McCarty reports that his company's loss mitigation efforts represent a "huge part" of its culture and, therefore, are not limited to hurricanes. The company uses a Bloomington, Ill., laboratory to evaluate the effects of wind, roof collapse and more.
The same philosophy is used by the company to monitor its aggregate loss limits. "We monitor aggregates, yes, but not only specific to coastal risk," he says. "We also monitor for hail and other perils."
Gary Kerney, head of ISO's Property Claim Services (PCS) unit, Jersey City, N.J., maintains that there are no downsides to obtaining accurate damage estimates, understanding true replacement costs and focusing on exposure concentrations in any given CAT loss.
"Insurers can use this information to drive efficiencies in the claims process, such as establishing a field presence and call centers," he says. Additionally, carriers can make better decisions about where to alleviate over-concentration of risk, where to write new business, and how to set more appropriate loss reserves.
"Back in the old days, agents and underwriters stuck pins in maps to avoid over-concentration," says Kerney. "As geo and mapping technologies become more available, carriers of all sizes will move in this direction. Insurers are beginning to understand that those are pieces of information they need to have."
McCarty says that one of State Farm's priorities is to keep an eye on exposure concentrations, and admits having pockets of exposure that the company has some concerns about.
"Some of what you've been hearing about in the press goes back to accusations of insurers' inability to gather appropriate enough information relative to what their exposure is," he says. "With our homogenous book of business, we don't have that situation."
Whether insurers are able to gather enough information is but one critical element of the CAT risk management discussion, notes Pauli.
"Insurers understand they need specific risk information on each and every structure they write," she says. "They haven't done this in past, so they need an agent or a software vendor that provides insurance-to-value support."
Independent loss adjusters also depend on insurance-to-value tools. After Katrina, Karl Mann, director of P&C for Dallas-based Cunningham Lindsey U.S. Inc., relied heavily on electronic estimating platforms, such as those provided by Los Angeles-based Marshall & Swift/Boeckh (MS/B) and Exactimate from Xactware, Orem, Utah.
Mann recalls assigning a "significant complement" of adjusters to Katrina losses, but in spite of having both technology platforms at his disposal, as well as laptops and a host of other means for mobile communication, the adjusters found that property sites no longer existed.
"We pride ourselves on being proactive, discussing with the carrier what individual policy limitations are, fee agreements, etc., as part of our advance preparation," says Mann. "We weren't prepared to get to that area and find property sites that no longer existed, street signs washed away, whole blocks no longer visible, areas that were closed or restricted to us, and policyholders who were evacuated to unknown locations."
David Rapinski, Cunningham Lindsey's president and CEO, reports that the company's biggest challenge was finding adequate numbers of trained adjusters to deploy to Katrina's ground zero.
Rapinski describes the life of an adjuster as difficult, but more so after Hurricane Andrew hit in 2002. "It hasn't been a good decade to be a CAT adjuster," he says.
Adjusters must receive training, keep up with CE credits and in many states must be certified. Their time in a hotel or trailer depends on the size of the loss, and they are only paid when they are working. With the number of CAT losses experienced by 2004, the industry was starved for adjusters, Rapinski points out, because a lot took their money and went home saying 'I'm done.'
"For Katrina, technology was less of an issue, as we struggled to find qualified adjusters and get them to the right spots," he says.
In Guin's experience at AIR Worldwide, a key obstacle faced by many carriers during Katrina had more to do with the quality of the insurance-to-value data that was being fed into the various CAT models being used by insurers.
"This is a critical element of the risk analysis," Guin points out. "The claims team often underestimates those replacement values." (AIR's parent company, ISO, offers replacement estimation tools).
Rapinski believes it's more an issue of CAT-situational supply and demand.
"Market forces affect pricing," he says. "In the aftermath of a catastrophe, typically there are no locally available materials, and no contractors to do the work. All this adds costs. If the policyholder decides to have the roof replaced without first receiving an estimate, it may cost three times as much as expected. This spins forward into negative policyholder relations."
Pauli, however, blames antiquated systems as the biggest obstacle.
"We have a client with 12 different systems," she says. "A lot of carriers don't have any buckets left in which to put this information, so the hitch and giddy up is still the legacy system."
Eqecat's Larsen offers a perspective that carries more hope. "CAT modeling used to be considered boutique software; it resided on the desktop," he says.
Now, reports Larsen, some insurers are integrating it into their underwriting process as a roll-up, which involves automation and integration into an insurers' full process. By using the tools and technologies associated with that, it enables insurers to define their risk levels in real-time.
"Policies are added and dropped every day," Larsen says. "This enables insurers to keep their thumb on risk and have better control."
In the long run, having better control over the myriad complexities that comprise CAT risk management may affect policyholder and the general public's perceptions. Meanwhile, the industry has some work to do, says RMS's Muir-Wood.
"There has been an attempt to find scapegoats," he says. "The outcome of what happened in Florida has not been to the benefit of the industry. As a modeling company, we would like to focus the agenda on helping carriers understand how to use the models to drive risk levels down. To bring confidence back to the market, the entire industry needs to demonstrate a willingness to participate in the solution."
State Farm's McCarty says his company is trying to build the public's confidence levels by promoting its work with the Institute for Business and Home Safety, Tampa, an organization that works to reduce the social and economic effects of natural disasters and other property losses by conducting research and advocating improved construction, maintenance and preparation practices.
For Mann, it's more a matter of educating the public. "We all buy insurance; there's nothing glamorous about it. But how many policyholders really read and understand their coverage limits? I don't think the public is any more educated now than they were 33 years ago when I started in this business."
Rapinski believes that educating the public should be considered part of an insurer's overall risk management efforts. "If the public feels it's getting the short end of the stick, the industry needs to help rebuild trust."
Guin maintains that carriers that first understand what elements of losses are covered and are not covered under their respective CAT models may be able to overcome other hurdles along their respective learning curves.
"If you have only so much money to spend, hire the people who really understand what to do with all the data," he says.
McCarty looks at the bigger picture. "What works for State Farm is that everyone is involved," he says. "In dealing with risk management, it's an enterprise effort-everyone is accountable."
WHAT CAN CARRIERS LEARN FROM REINSURERS?
As one of the foundations of the insurance industry, traditional catastrophic risk management considers the possibility of loss from natural, physical causes by looking at past events, and uses predictive analysis to study-and ultimately predict-the likelihood of future disasters.
By their nature, reinsurers take a much larger, often global look at risk, and for years have been successful in quantifying how CAT hazards may affect an entire portfolio, says Karen Pauli, senior analyst with TowerGroup, Needham, Mass. This is the result of detailed and disciplined risk management planning- and a demand for accuracy from its ceding companies.
"Reinsurers look at the whole property book and will demand that an overall risk management control effort is in place," says Pauli.
Swiss Re views itself as a good model for how to manage portfolios of risks as well as individual risk, says Andrew Castaldi, head of catastrophe perils at the company's Americas division, Armonk, N.Y.
"Understanding the financial impact of large natural catastrophes is of critical importance to the reinsurance industry because this is our core business on the property side," he says. "We are able to go broad and deep."
Castaldi says going broad means that by underwriting on a global basis the company is familiar with a wide variety of hazards and how these hazards might affect a portfolio. Going deep means the reinsurer understands the individual risks that make up a portfolio.
Over the years Swiss Re has developed sophisticated analytical capabilities that help bring clarity to the uncertainty surrounding loss analyses. In addition, reports Castaldi, the company has developed technology to evaluate the true nature of all aspects of loss, including the flooding and storm surge component, in order to quantify those risks.
Castaldi acknowledges his company's concern about the quality and scope of data captured and how it may be transferred from one entity to another.
"If the underlying information is suspect, then any analysis will be equally suspect," he says. "Adjustments can be made. but we must be careful not or over-compensate or underestimate for inadequate data. If we don't understand the individual elements that make up the big picture, we may never be able to properly interpret the big picture."
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