Critical Issue Report
June & beyond—gentle breezes or costly storms?
2008 hurricane season—with its potential market-changing impact—is just ahead
By Phil Zinkewicz
This is the month of June and, according to the songwriters, it should soon be “busting out all over.” It brings warmer days, with populated beaches; the intoxicating scent of flowers in full bloom; and backyard barbecues, with steaks and chicken and sausages, grilled to perfection. Father’s Day is in June, and what better gift to give the old man than a couple of tickets to the ol’ ball game. All is well, as we anticipate a long and playful summer.
But wait! June has another more sinister reputation. It is the beginning of the hurricane season, a season that reaches all the way into November. Depending on the magnitudes of the tropical storms that might turn into hurricanes, the damage to coastal states can be merely destructive, as they have been in the last two years, or they can be devastating as they were in 2004 and 2005, particularly when Hurricane Katrina hit.
For the insurance industry, the severity of the losses can mean a painful tightening of the belt, or it can mean a complete turnaround of market conditions as happened following Katrina. The property and casualty insurance market is soft today, coming off two years of significant industry profits. But it can turn quickly if a severe enough hurricane hits the U.S. coastline.
The Insurance Information Institute (I.I.I.) reports that the final tally for Hurricane Katrina losses is $41.1 billion, stemming from 1.75 million claims. By contrast, losses for 2007, a year of little hurricane activity in the U.S., were $6.5 billion, according to the Insurance Services Office’s (ISO’s) Property Claims Services. That figure represents losses stemming from 23 events, 17 of which were severe weather events (wind, hail, tornadoes and flooding); five were winter storms and one was a wildfire.
Says the I.I.I.: “In the U.S., the unexpected lull is giving the insurance industry a chance to bolster its policyholder surplus, the capital that it relies on to pay disaster claims. Meanwhile, the magnitude of the damage caused by Katrina and the potential damage hurricanes Rita and Wilma might have caused had they not weakened from intense Category 5 hurricanes has triggered a re-examination, not just among insurers and reinsurers but also among public policy and political leaders, of how the United States insurance industry deals with the financial consequences of such massive property damage and personal loss.”
Risk transfer vehicles, such as sidecars and risk-transfer securitization instruments, have come into prominence. Catastrophe bonds and industry loss warranties have all seen market increases in issuance and use. These instruments, all of which are largely funded by the capital markets, provide capacity while shielding issuers and sponsors from the risk’s direct financial impact.
Commenting on that in a recent research paper, Standard & Poor’s said: “It is evident that the insurance industry, like other industries, is increasingly turning to the capital markets as a source for risk mitigation. Investors, which include hedge funds and private equity as well as dedicated catastrophe funds, see this sector as an attractive place to invest capital for relatively short terms in anticipation of high returns.”
It is hoped that these capital investment vehicles will take some of the sting out of severe hurricane losses when they occur, but whether they will remains to be seen.
What’s in store for the United States now that this year’s hurricane season has begun? New research from AIR Worldwide suggests that the degree of hurricane activity in the Atlantic Basin is not a proxy for the number of storms that are going to make landfall along the U.S. coastline. According to their researchers, the probability of a landfall is linked most closely to a storm’s genesis, or where it forms, rather than the number of tropical storms in the Atlantic. Genesis patterns change from year to year.
The key to understanding why in some years the number of storms that make landfall in the U.S. is high and in others it is low is to compare long-term genesis patterns, the AIR study noted.
In their first forecast of hurricane activity for 2008, Colorado State University’s Philip J. Klotzbach, research scientist, and Dr. William M. Gray, Professor Emeritus of Atmospheric Science, predict a somewhat above-average hurricane season and an above-average probability of a major hurricane making landfall in the United States. “Current oceanic and atmospheric trends indicate that we will likely have an active Atlantic Basin hurricane season,” says Dr. Gray, who is beginning his 25th year forecasting hurricanes at CSU.
“Based on our latest forecast, the probability of a major hurricane making landfall along the U.S. coastline is 60% compared with the last century average of 52%,” says Klotzbach, one of the leaders of CSU’s forecast team.
Dr. Gray’s predictions are watched closely by emergency responders and others in coastal areas.
The National Oceanic & Atmospheric Administration (NOAA) is predicting 13-17 named storms for the coming season, 7-10 hurricanes and 3-5 major hurricanes.
Risk Management Solutions, a leading provider of catastrophe risk modeling data, says that insured losses in 2008 are likely to be 40% higher than the historical average for the Gulf Coast, Florida and the Southeast and 25%-30% higher for the mid-Atlantic and Northeast coastal regions. It would appear that predictions of hurricanes for the short term do not present an Armageddon situation, but how about 20 years into the future?
A recent Reuters report cites a study published earlier this year that found that a hurricane that struck Miami in 1926 would cause $157 billion in damages if it were to strike today, adjusting for inflation and current building. The study suggested there could be a $500 billion hurricane by the 2020s. The Reuters report quotes Max Mayfield, former director of the U.S. National Hurricane Center, as saying that the damages from hurricanes seem to be doubling every 10 years. “As we continue to build along the coastline, the damage is going to continue to go up,” said Mayfield. “There’s no way around that.”
Moreover, the growing hurricane problem is not limited to the United States. Munich Re, the world’s second largest reinsurer, says that estimated insured losses from natural disasters (which include hurricanes) doubled to about $30 billion in 2007 from 2006. Storms and flooding led to 15,000 deaths and $75 billion in total damage costs. The number of natural catastrophes rose to 950, the highest since the reinsurer began keeping records in 1974. Total insured losses, however, remained well below the record $99 billion in 2005, the year Katrina hit.
The questions are: when will the next Katrina hit and are we prepared for it? Government and private engineers are still working diligently to shore up the city of New Orleans in the wake of Katrina. But that is only one city along the entire U.S. coastline. *
The author
Phil Zinkewicz is an insurance journalist with some 30 years’ experience covering the international insurance and reinsurance arenas. He was the insurance editor of the Journal of Commerce for a number of years, handling all their domestic and international supplements. In addition, he regularly writes for a number of London publications.