July 25, 2006 Convention Presentation
by John Gilleland, CPCU
Insurance for Natural Catastrophic
Purpose: This paper was developed using information gathered and opinions formed in preparation for a seminar during the Professional Insurance Agents of Louisiana’s annual convention on July 25, 2006. The seminar used structuring techniques to organize information about natural catastrophes and how insurance markets have reacted to those disasters.Outline: 1. We need a prearranged solution for a reoccurring problem.
2. The The underwriting cycle does not explain the P&C market after being shocked by natural catastrophes.
3. Since 1992 catastrophic natural disasters are disrupting the P&C market with greater frequency and severity.
4. Many P&C market participants are putting forth more effort and creativity to meet the challenge posed by natural catastrophes.
5. The illustration on page 3 shows how a continuous seamless series of indemnification could be coordinated to respond to insured catastrophic losses thereby stabilizing the P&C market after shock losses.
6. This paper is offered to help readers make better preparations for losses caused by natural catastrophes.
Summary: Risk management professionals’ (e.g., sales people, underwriters, actuaries, risk managers) work is becoming more important as a result of consumer behavior and increased catastrophic loss frequency and severity. Population distribution in disaster prone areas is causing property values to increase and catastrophes are becoming more common and significant.
This paper was prepared using materials presented at the annual convention for Professional Insurance Agents of Louisiana. It reflects the author’s personal belief that customer-committed entrepreneurs who have chosen risk management in general and insurance in particular are willing to innovate to improve their ability to serve customers. Like the American cowboy of our past, they are clever in being flexible and committed to hard work. The presentation was developed to increase our understanding and ability to serve clients willing to pay for our services. As was stated in the program’s approval request: In July of 2005 the market was softening, consumers were relatively comfortable with the system, and most policyholders thought hurricanes and floods were “other people’s problems.” In a post-Katrina/Rita world consumers are much more aware of their vulnerability to loss, more demanding of their agents for cost effective coverage, and aggressively seeking (often for the first time) Business Interruption and Excess Flood Coverage and other coverage that had never been of interest. Unfortunately, now that the demand is there, the supply is nearly non-existent or unaffordable. What’s an agent to do?
This description of prevailing market conditions is substantiated by several sources. The Insurance Information Institute reported 2005 started off with the industry reporting an average statutory rate of return on surplus of 15%, an increase of 50% over 2004’s 10.5%. That is 1% better than the Fortune 500 group of companies for 2005. The industry had not performed that well since 1987. These conditions were present the year before the keynote speaker at a catastrophe conference in Baltimore, Maryland announced: catastrophe losses “will double about every 10 years due to increases in the number and values of properties at risk.” (From Insurance Networking News 4/25/06)
Unfortunately, too many people were living in the moment of prosperity and not the heat of preparation. Times of prosperity are often exaggerated as assurance by those who benefit when things are going well. Those who know and rely on the insurance market’s underwriting cycle are not prepared for the effects of shock losses caused by natural catastrophes. The underwriting cycle has been compared to time on a clock by Paul Ingrey.
In 1985 Paul Ingrey, then President of F&G RE, used time on a clock to illustrate a frequently repeated sequence of events labeled the Underwriting Cycle. His illustration explains what has been the traditional insurance market cycle in terms of pricing, profits, reinsurance, underwriting, emotions, and cash flow.
1:00 – pricing starts to drop and underwriting is relaxed
2:00 – companies take more aggressive actions to increase market share
3:00 – prices fall dramatically
4:00 – profits slide as margins have been reduced
5:00 – underwriting results are horrible
6:00 – pricing cannot go lower
7:00 – A.M. Best writes this decade’s “letter of concern”
8:00 – crunch underwriting becomes restrictive
9:00 – prices increase sharply
10:00 – capacity becomes expensive for insurers
11:00 – most if not all companies flourish
12:00 – success leads to euphoria and it all starts over again
Based upon historical observations made after hurricanes Andrew in August of 1992, Iniki in September of 1992, and Katrina in 2006, the following illustration was prepared as a generalization of how markets reacted to losses in the billions.
Regrettably, insureds experience similar mindsets after catastrophes frequently. Few have the luxury of the calming effects of emergency preparation (e.g., disaster kits, food storage, transportation using foam filled tires, gas powered generators, calling trees). This paper and its presentation were developed to encourage and enable risk management professionals to better plan for their personal and professional recoveries after catastrophes.
Fortunately, there is hope that the disturbing emotions illustrated above may begin to be mitigated by proper planning preventing poor performance after natural catastrophes. Evidence has been discovered indicating:
· Insurers have improved their modeling techniques and those modeling techniques are being used more often and more earnestly.
· A new kind of insurance-linked security called catastrophe bonds “CAT bonds” was developed in 2001. Zurich Financial Service’s $190M bond named Kamp Re 2005 was available to cover Zurich’s Katrina losses.
· Sometime after 2001 the investment community introduced another insurance-linked security called industry loss warranties “ILWs”.
· States' departments of insurance are reacting in more market friendly ways. (e.g., Florida building codes* and their enforcement were improved after Hurricane Andrew; Louisiana’s Commissioner of Insurance Robert Wooley did several things like such as inviting insurer Cat teams to office in Louisiana’s department of insurance building after Katrina)
* *Implementation of significant hardening items and practices could restore insurer and consumer confidence. If construction of new structures and retrofitting of older properties were spurred by state and local governments, properties would become hardened against windstorms. If insurers began documenting such improvements and using documentation in their rating of property insurance risk exposure mitigation would be reinforced and encouraged to spread. Florida International University has an established program which has been documenting the effectiveness of the construction materials and practices it has tested. Such documentation may be used property insurers when underwriting and rating applicants’ properties. If a systemic solution is implemented, storm victims will be less likely to spend time in the Catastrophe Recovery Cycle illustrated above.
Here are three related questions:
· How do you believe the markets have been responding to natural catastrophes?
· What is your mental model of how the P&C market works in response to catastrophic losses?
· How might parties’ efforts to indemnify and assist in recovery efforts after catastrophes be illustrated?
These are offered to direct readers to think how our risk management industry works before, during, and after natural catastrophes. These are how-to questions; they do not concern why or how well the market works.
Here is an illustration of what could be developed if the P&C market can be educated and participants are willing to negotiate collaboratively. This is realistic because these items are in place though they are not arranged/used as logically as this illustration shows. An explanation is offered on the next page.
The illustration above was created assembling two lists. By listing, in order of severity,:
· financial devices used to pay for losses caused by natural catastrophes. This list was used to create the graph’s x (horizontal) axis.
· entities who participate in efforts to pay for losses caused by natural disasters. This list was used to create the graph’s y (vertical) axis.
Horizontal and vertical lines were added to suggest thresholds separate ranges covered by each device and each entity. More research is needed to logically approximate the points at which the thresholds should be set on the horizontal axis. Unfortunately, this illustration glosses over deficiencies in coverage such as the $250,000* cap on national flood coverage for wealthier homeowners and the virtual lack of coverage for low income homeowners. There are also gaps in disaster coverage because too few property owners develop thorough risk management programs in ways that weave coverages and limits together tightly.
^ ^ Listing items in order of their significance is a technique which aids decision making and is used too seldom in our industry. Listing items such as hazards and perils helps structure or organize data so better decisions can be made. See The Thinker’s Toolkit by Morgan D. Jones and www.profitableunderwriting.com for more on this subject.
** Residential insurance for one- to four-family unit buildings and individual residential condominium units are written under the Dwelling Form and are eligible for up to $250,000 in building coverage and up to $100,000 on personal property coverage. On average, the cost of a flood insurance policy on a home is about $400 a year for around $100,000 of coverage.
Repeatedly, executive decision makers have disrupted markets and discredited front-line risk management professionals by limiting wind coverage after windstorms and limiting earthquake coverage after earthquakes. Most business leaders react to increased demand for their products and services by charging more and, occasionally, supplying more product when demand increases. Limiting availability of coverage is more disruptive, discouraging, and discrediting than limiting exposure to coverage. Changing policy forms to limit insurer exposure to coverage introduces change more gradually and therefore enables planned improvements fostering better customer relations.
A logical, fact-based preemptive strategy is almost always preferred over a reactionary spontaneous plan in capitalist economies. Strategies, communicated transparently and implemented in a comprehensive manner, offer teams greater opportunity for success and improved chances of improvising remedial options if the main plan fails.
In the face of catastrophic disaster people tend to react according to how they feel. The following illustration shows how feelings often transition across a wide spectrum of emotions.
The Flood Insurance Reform Act of 2004 brought some improvements to flood coverage in the US. In November of 2005 the IIABA released 22 recommendations aimed at improving the National Flood Insurance Program. The Flood Insurance Reform and Modernization Act of 2006 made more significant, though belated, improvements. www.floodsmart.gov encourages people to prepare, participate, and protect. This paper suggests preparation of a plan for an array of participants working together in collaborative ways to improve protection before and after catastrophic disasters.
Information about recent catastrophes and this paper could be used during sales and service calls by P&C professionals to help them round accounts. Two guidelines can help us have quality communication concerning this important subject:
1st – We should understand our abilities and how our industry works before expecting outsiders to understand us.
2nd – We should understand our customers before seeking to be understood by our customers.
The fundamental steps recommend for success are:
# 1 – Understand yourself.
# 2 – Understand others.
# 3 – Enable others to understand you.
Here are questions to help us understand ourselves:
a) How did we cope with life after hurricanes Katrina and Rita? Those experiences should be used explained as testimonials when selling to prospects and servicing clients.
b) How have we been explaining the market’s reactions to losses caused by hurricanes Katrina, Rita, and Wilma? Clients should be encouraged to learn from each other’s experience instead of generic interpretation of policy provisions.
Prospects and clients wanting tangible proof of why things are the way they are, could be shown a list of disaster preparation assets* and resources or your agency’s disaster preparedness supply room complete with generators, canned goods, and motorcycles with foam filled tires. Slide 44 is a disaster kit recipe I found in The Advocate from Baton Rouge on May 28, 2006. Encourage your prospects and clients to be prepared to endure being stranded or homeless for three to five days after the next direct hit of a hurricane.
Prospects and clients wanting emotional assurance of their acceptance of your offer to insure them should be given your personal assurance as well as unique documentation to read and store in a special place. They should be shown your “calling tree” system so they are assured they will not be forgotten after a catastrophe.
* The January 1999 edition of the Journal of the
Professional Independent Insurance Agents of Illinois
published an article titled Catastrophe Planning Today! by
Grace Bauer on pages 33 to 34. I recommend it be used with other articles to
encourage agency and insurer decision makers to prepare a
personalized disaster plan for their personnel. The article titled Katrina Disaster Taught Valuable
Lessons in National Underwriter’s February 27,
2006 edition has a great list for insurers’ disaster plans
titled “What to Do Next Time”. Planning to provide for
employees’ families before and after a disaster will enable
employees, in turn, to provide for insureds/customers.
1. Express empathy with your prospect and client by telling how you have been affected by past catastrophes and are preparing for future challenges.
2. Probe deeper by asking follow up questions in response to what the prospect/client is telling you. Listen and learn so you will understand.
3. Recognize the prospect’s/client’s social behavior style and tailor your response to fit their expectations.
4. Verify how well your response meets their needs.
5. Ask for their commitment to do as you recommend and move forward to success in spite of the adversity they are having to deal with.
Here is an illustration of how disaster preparation could be approached as steps in a planned process:
Here is an illustration of how disaster recover could be approached as steps in a planned process:
What should you do as a risk management professional to create your own tailored version of a template or process to use when explaining this information to your customers?
In summary, please believe your work, your profession, trade, and industry, is now needed more than ever. Lives have been and will be torn apart. This urging is based upon what the author has learned preparing for his presentation about coastal population migration and coastal area catastrophic disasters. People have been relocating to attractive coastal regions ahead of increased storm frequency and severity. In addition to the devastation of Katrina, the year 2005 had so many storms that it beat a frequency record that had stood since 1933. Please know yourself, know your industry, and work smarter at serving your customers.
Clearly, Katrina and related catastrophes, are encouraging a national resolve to do better in the face of disasters. Please contribute to the national debate and local risk management efforts so your resolve to succeed will not be in vain. Take what you agree with from this paper, develop your own process, begin lobbying with what you develop, and build a better tomorrow.
Here are questions for you to study and react to soon:
1. Should insureds pay the market price of catastrophe risk? If so how?
2. Should rebuilding after repeatable catastrophes be prohibited or just uninsured? If so how?
3. Should poor and otherwise disadvantaged people be indemnified after catastrophes? If so how?
4. Should insureds who are not affected by catastrophes pay for indemnification of injured parties who do suffer catastrophic losses? If so how?
5. How should indemnification after catastrophes be funded? If so how much?
6. And last, how can you better analyze the P&C market so you make better decisions as a player in the market?
A prearranged solution will require consensus building facilitated by education and negotiation. As indicated by the preceding questions, this paper does not have all the answers. This is offered to spur communication so learning and negotiating can move forward.
Thank you for reading this. If any of you have questions, comments, or concerns for the author please contact him through www.profitableunderwriting.com. Rebuttal is invited.