Hurricane Models Not Up to Snuff

This time of year, much of the talk of estimates has to do with football teams underestimating their opponents. However, when it comes to the insurance industry, the opposite seems to be in effect. A report issued today by Karen Clark & Co. an independent firm specializing in catastrophe risk, models and management, released its third annual assessment of the performance of near-term hurricane models.

The report finds that the models, designed to project insured losses in the United States from Atlantic hurricanes for the 2006 through 2010 seasons, have significantly overestimated losses for this cumulative five-year period. The company’s previous reports came to the same conclusion for the 2006 through 2008, and 2006 through 2009 seasons.

Near-term models were introduced by the three major catastrophe modelers—AIR Worldwide (AIR), EQECAT and Risk Management Solutions (RMS)—in 2006, following the disastrous and costly 2004 and 2005 hurricane seasons. Each of the three major cat modelers initially projected insured loss levels at least 35% above the long-term average for the period 2006 through 2010, notes Karen Clark & Co. AIR eventually lowered its figure to approximately 16% in 2007, while EQECAT only made minor adjustments to its original estimate of loss increases of between 35% and 37%. RMS eventually made modifications to its model in 2009, but still predicted losses 25% above the long-term average.

Assuming long-term average annual insured hurricane losses of $10 billion per year, these percentages translate into cumulative insured losses for 2006 through 2010 of $60.4 billion, $68.2 billion and $67.2 billion respectively, for the AIR, EQECAT and RMS models, the report says.

However, the actual cumulative losses were just $15.2 billion—significantly lower than the model predictions, and less than one-third of the long-term cumulative average of $50 billion. No hurricanes made landfall in the United States during the 2010 season and, consequently U.S. insured property losses were minimal, notes Karen Clark & Co. This is in spite of the fact the 2010 season was one of the busiest on record, with 19 named storms in the Atlantic, of which 12 became hurricanes and five became major hurricanes of Category 3 or higher.

“Now that we have completed the first five-year near term hurricane model projected period, it has become clear, as our previous reports have found, that a short time horizon is not sufficient for credibly estimating insured losses from hurricanes,” said Karen Clark, president and CEO, Karen Clark & Co. “Tropical cyclone activity changes markedly year to year, and even a near-record season of storm activity such as 2010 does not necessarily translate into large insured losses.”