Chicago — Risk managers and insurance companies should consistently employ robust enterprise risk management strategies and business continuity programs, but it is particularly important as the start of the 2008 Atlantic hurricane season approaches, according to Chicago-based Aon Corp. Aon’s statement is seen largely in response to leading forecasters’ expectations for 2008 to be an active one for hurricane and tropical storm formation.
The National Oceanic and Atmospheric Administration's May 22 updated forecast calls for 12 to 16 named storms between June 1 and Nov. 30. Other major forecasting organizations also believe conditions are ripe for an active storm season.
New York-based Fitch Ratings Ltd.'s annual hurricane season desk reference guide echoes this forecast. "Forecasts for 2008 call for an above-average hurricane season," says Donald Thorpe, senior director, Fitch Ratings. Fitch reports that 2008 follows a season in which there were little or no hurricane losses for most insurers. In fact, 2007 was the second consecutive year in which high levels of hurricane activity were predicted and insured losses were minimal.
“Fitch believes this situation has negative implications for insurer solvency and profits because it fosters complacency on the part of both policyholders and insurers. More importantly, it provides political ammunition to those who would weaken long-term industry solvency for near-term insurance price reductions."
The low severity of property catastrophe losses since 2006—resulting in part from the relatively small number of land-falling hurricanes and tropical storms in the last two years—is one driver of what Aon Re Global expects will be favorable pricing for traditional property catastrophe reinsurance programs for insurers' mid-year renewals.
Whether or not predictions of mass destruction are accurate, some experts say reinsurers should look at the big risk management picture.
"While predictions of hurricane activity are important, insurance and reinsurance buyers must remember that any storm can cause massive destruction, whether that storm occurs in a season of above-normal activity or below-normal activity," says Steven Drews, lead meteorologist and associate VP of Impact Forecasting LLC, a unit of Aon Re Global. "Hurricane Andrew in 1992 and Hurricanes Dean and Felix in 2007 each caused massive destruction--during periods of relatively light activity."
A recent Aon Re Global study of insurance company stock price reaction to 2005 Hurricanes Katrina, Rita and Wilma found that insurance company stock prices were more sensitive to a single large loss (i.e. Hurricane Katrina alone) than to an aggregation of loss events (i.e. Katrina, Rita and Wilma combined). The Aon Re study underscored the view that insurers can best drive shareholder value by consistently managing the enterprise risks facing their businesses. Ceding risks through the reinsurance markets is one method of doing so.
Should reinsurers prepare to bear the brunt of losses? Fitch Ratings predicts yes. Historically, the allocation of catastrophe losses between insurers and reinsurers depends greatly on the number of storms, the severity of the storms, the areas affected and the relative size of the primary insurer. Additionally, the competitiveness of the reinsurance market and the level of reinsurance prices relative to primary insurance prices also affect this relationship, according to Fitch. As a general rule, Fitch believes primary insurers will disproportionately incur catastrophe losses relative to reinsurers if the season is one of several small to moderate storms as experienced in 2004. Conversely, if the season includes one or more large to very large events (such as 20 5), then Fitch believes the burden of losses tends to shift to reinsurers.
One reinsurance specialist taking action is Guy Carpenter & Co. LLC. The New York-based company collaborated with WSI Corp., an Andover, Mass.-based provider of weather-driven business solutions, to introduce WSI LiveCat Forecast, a service for the insurance marketplace designed to provide accurate 10-day predictions of the path and intensity of upcoming hurricanes and tropical storms. WSI LiveCat Forecast employs meteorological models to predict the direction, intensity and duration of a named tropical storm or hurricane, along with landfall probability, five days beyond the standard five-day forecast period currently predicted by the National Hurricane Center (NHC). This patent-pending technique is designed to enable insurers to establish advantageous market positions days ahead of those relying on NHC information alone.
Beginning on June 1, 2008, for each named tropical storm or hurricane, WSI LiveCat Forecast will issue:
1. Track and intensity forecasts for each named tropical storm or hurricane, twice daily, up to 10 days out;
2. Landfall probability forecasts that are dependent upon storm-specific track uncertainty rather than historical error statistics;
3. Weather forecasting skill comparable to or better than the National Hurricane Center WSI LiveCat Forecast is available either online or via GIS shape files.
Sources: Aon Corp., Fitch Ratings, Guy Carpenter & Co. LLC
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