Tsunami!
For questions about coverage, specialty carrier RLI has answers
By Elisabeth Boone, CPCU
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For answers to these and other questions about the tsunami risk, many agents turn to wholesalers who represent RLI Insurance, an A+ rated specialty carrier based in Peoria, Illinois. RLI offers earthquake and flood insurance, as well as difference in conditions (DIC), for commercial risks.
Kevin McDonough, vice president of underwriting at RLI, brings to his position years of experience in the commercial earthquake insurance market, managing RLI’s portfolio in northern California and the Pacific Northwest. Understandably, he notes, the demand for earthquake coverage is based on insureds’ geographic location—and here, McDonough observes, perception of the risk doesn’t always square with geological reality. “People in Oregon, for example, seem to think they’re immune to earthquakes, so they don’t buy the coverage,” he says. “This holds true even though there’s been a 7.0 earthquake near the northern California border. This perception changes again when you cross the border into Washington.”
The risk of earthquake and following tsunami is taken very seriously in America’s 49th and 50th states. In January 1964, a tsunami triggered by an earthquake off the coast of Alaska resulted in more than 100 deaths in Alaska and killed four people in Oregon and 13 in California, in addition to causing some $100 million in property damage. Hawaii faces a double-barreled threat. First, it’s located in the path of tsunamis that are unleashed in the Pacific Ocean’s volatile Ring of Fire, where the shifting of tectonic plates can trigger powerful earthquakes; and second, it’s vulnerable to massive mudslides generated by volcanic eruptions, which also can cause tsunamis.
Nor is the East Coast of the United States immune to the tsunami threat. Scientists warn that a volcano in the Canary Islands, located off the coast of Morocco, could erupt and send a wave of tsunamis speeding through the Atlantic Ocean, possibly causing 50-foot waves to hit the U.S. East Coast.
Evolving Coverage
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The demand for earthquake coverage is based on insureds’ geographic location—and … perception of the risk doesn’t always square with geological reality. —Kevin McDonough |
What kinds of exposures are covered by the difference in conditions policy, and how is the coverage structured? “DIC originally was a wraparound or supple-ment to a named peril fire policy,” McDonough explains. “As the industry evolved and all-risk became the basis for property coverage, DIC was relegated to the status of coverage for earthquake and flood.” The reason for this shift, he says, was that “most of us had treaties with reinsurers that specifically said we wouldn’t write earthquake or flood risks as such. The mechanism to provide this coverage became the DIC policy. It still serves the purpose of picking up the unknown perils that people haven’t thought of or experienced yet, but that tends to be very rare.”
In the RLI policy, McDonough explains, an earthquake is defined as a seismic event; water-related exposures are picked up by the policy’s flood coverage. In addition to arranging primary DIC coverage for retail agents’ clients via wholesalers, RLI also provides excess capacity on large commercial accounts. In this case, McDonough says, “The coverage is written on the brokers’ manuscript forms. Those policies tend to be earth movement policies, which includes man-made earth movement, mudslides, and subsidence.” RLI also covers damage from volcanic action, which is a particular threat for Hawaii and the Pacific Northwest.
For business owners who face the risk of tsunami damage, the most pressing concern is: “Can I get coverage?” At RLI, the answer—subject, of course, to terms and conditions that reflect the exposure—is a qualified “yes.” The premium for DIC coverage is based on the rates for earthquake, flood, and other perils. The rates may be adjusted for layered policies (first loss or excess). Minimum premiums reflect current conditions and expenses, including but not limited to catastrophe reinsurance capacity, portfolio probable maximum loss analysis, and individual risk evaluation and exposure to known earthquake faults, flood zones, and other risks. Coverage is available for commercial and high-value residential property and inland marine exposures.
RLI offers earthquake coverage of up to $10 million on any one policy or risk. Using approved facultative reinsurance allows RLI to provide full limits up to $15 million. Coverage applies to both direct damage and loss of business income. Coverage is available in all 50 states and is offered through wholesale brokers located throughout the country.
What kinds of commercial operations are eligible for RLI’s earthquake coverage? “Occupancy of an insured property will affect our estimate of the probable maximum loss,” McDonough says. “For example, if a property contains extremely fragile material, we would probably want a higher rate. Conversely, we would provide a credit if the insured had a lot of heavy machinery that’s not likely to suffer much damage. There’s no particular class of occupancy we try to avoid. As for building categories, we stay away from unreinforced masonry, and we typically will not write coverage for buildings constructed prior to 1950. If there’s been seismic retrofit to allow the building to withstand an earthquake, we’d give some consideration to insuring it.”
In underwriting earthquake exposures, McDonough says, “Probably the biggest single factor is the address. The address tells us virtually everything we need to know. We have to trust the insured to some extent on the construction type and the age, but as you work in this market, you get a sense of what you’re going to find in most neighborhoods,” he says. “The address also tells us about the soil and the property’s distance from the fault, and those are important factors in developing a rate and determining the limit of coverage we’ll provide on a given risk.”
Assessing flood risks
In addition to earthquake, the DIC policy is designed to cover flood exposures—including tsunamis and mudslides. Here too, location is a key factor in evaluating risks. “We typically want to stay away from 100-year flood plains, and we’re somewhat conservative going up to the 500-year level,” McDonough says. “We also typically exclude Zone V, which is coastal; we don’t want to write either flood or earthquake coverage on beachfront property.” RLI covers tsunami damage under its flood coverage.
“Our main focus is on earthquake insurance, and we write flood insurance to enhance the production of earthquake business,” McDonough says. For that reason, he notes, “I’m very conservative about taking on a flood exposure.” Because tsunamis are so rare and RLI avoids coastal properties, he adds, “We won’t have an accumulation problem, at least in the foreseeable future, and we’re getting an excellent rate for the exposures we do pick up.”
Since the killer tsunamis of last December, McDonough says, he hasn’t seen much concern about the peril on the part of insureds. “It’s possible that down the line we’ll see more requests for coastal exposures, and the markets that have been picking that up might become more conservative,” he comments. “At this point we hear a lot of talk, but in terms of business activity we’re not seeing any change at all.” Although insureds aren’t panicking, McDonough notes, the tsunamis can be expected to have some effect on the worldwide insurance market. “To the extent that reinsurers take a hit on this, it probably will show up in treaty costs by July,” he comments. “I don’t think it’s going to have nearly as much impact as the Florida hurricanes last fall, and they didn’t have much of an impact.”
Computerized forecast models play an important part in RLI’s earthquake underwriting process. “I think the model is best at picking up the exposure to soil conditions and the distance from the fault,” McDonough says. “The model gives us a fairly precise means of tracking our accumulation of business in earthquake-prone areas. Our rates tend to increase as we approach heavy accumulation areas where we can’t take on much more business. But if we get a better price for a risk than we’re getting on average, we’ll take it. Then our average premium increases. Those at the low end of the pricing spectrum will probably get a rate increase, and in today’s market we’ll most likely lose them,” he explains.
“In managing our earthquake book in areas where we have accumulation issues, we’re always looking to stay with an average or better rate. Accumulation is really the key to the whole business, because we buy our treaties to meet that need. The same treaties apply in Yuba City or Redding in northern California where there’s not a lot of exposure. To the extent that we can write business, possibly at a lower price, in those areas, we will want to, because we’ve already purchased the treaties to cover it.”
In RLI’s earthquake business, McDonough notes, the areas of heaviest accumulation are San Francisco Bay and the Los Angeles Basin. “The California economy is the sixth largest in the world, and 70% of the state’s economy is in those two areas,” he remarks. “There’s an accumulation issue for everybody who writes earthquake business and, to an extent that keeps the prices up in those two areas, to a far greater degree than we see anywhere else in California.”
Reinsurance is key
Insuring catastrophic exposures requires access to substantial reinsurance capacity with stable reinsurers, McDonough observes. After a catastrophic event, “we might have participants on our treaties that are severely weakened, and we have to be concerned about whether our treaties are strong enough, at least for the rest of that fiscal year,” he explains. “We watch our reinsurance situation very closely, and we make sure that those that are participating will be able to pay their bill when the time comes. After any major event like the Florida hurricanes last year, we take a serious look at the impact on our reinsurers—not just from the losses we gave them, but for what they sustained industry wide. If we have to realign our reinsurance support, we’ll do that,” he says.
Among the insurer’s leading wholesalers are Swett & Crawford, Tri-City, Crump Insurance Services, and American E&S. RLI also works with local firms like Crouse & Associates of San Francisco and Alexander Morford & Woo of Seattle, Washington. “The big national wholesale brokers probably account for about 60% of the business we write in the Pacific Northwest,” McDonough says.
In the wake of the South Asia tsunamis and given the potential for tsunamis here in the United States, McDonough encourages retail agents and brokers to review their insureds’ coverage to make sure they’re protected for tsunami damage. “Brokers should be diligent in determining whether an insured has a tsunami or mudslide exposure,” he says. “Brokers should be very careful to make sure that coverage is picked up—and if it’s picked up at all—and they should know where in the policy that coverage is coming from.” *