The Risks of Hazard

Wow, 2016 is now half over. It has been an eventful half year, including private flood legislation coming closer to implementation and historic wildfires in Alberta and California.

Earlier this month the New York Times published an op-ed piece discussing the new FIRMs in New Orleans. Now, if ever there were going to be contentious flood maps published by FEMA, these would be them. It is nigh impossible to discuss flood mitigation or flood risk in that city objectively after Katrina.

The author, Andy Horowitz (an assistant professor of history at Tulane), states his intent early: “I was briefly elated — and then, horrified — when, earlier this year, the federal government declared most of New Orleans safe from flooding.” At length, here is the cause for his concern:

Flaws and All

In 2014 Deloitte published a research paper entitled The potential for flood insurance privatization in the U.S. Could carriers keep their heads above water? Despite the marks the authors might have lost in the “Title Brevity” category, they more than redeemed themselves in the all-important “Usefulness” category. This is a white paper that anyone underwriting, contemplating, competing with, or studying private flood should read, over and over. It is such a rich vein of material that The Risks of Hazard is going to write two posts on it this week. Today, we will provide an overview that includes a deeper look at the key problem and solution. Later this week, we will review their survey of all the available ways that private flood can be introduced into the US market. 

The title of the introductory section reveals the conclusion: Greater privatization may provide growth opportunities, but leveraging them might be problematic. It is a very safe, uncontroversial conclusion, which makes sense because it was written 2 years before the current private flood legislation is on its way to becoming law. The first half dozen pages of the report offer an orthodox summary and summation of the NFIP, its travails and its successes (yes, it has been a success for some – especially lenders).

Then it gets more interesting.

Usually financial results are black and white, positive or negative, good or bad. However, the analyses of the P & C underwriting results from 2015 are coming in and looking decidedly gray – neither good nor bad.

According to an article in Insurance Journal, “...net written premium grew by 3.4 percent in 2015 versus a 4.2 percent hike in the previous year.” Further, “...the combined ratio grew to 97.8 from 97 in 2014. In 2013, the figure was at 96.2. As the ISO/PCI report points out, this is the first time the combined ratio was under 100 three years in a row since 1971-1973.”

On the one hand net premium grew, and the combined ratio was still in the black. Not only that, it’s the first time in over 40 years that there have been three consecutive years of positive combined ratios. Great! Right?

Earlier this month I published a post on LinkedIn about underwriting “challenging” flood in California’s Central Valley. It generated a decent readership and some likes, but, most importantly, it generated some comments. One of the comments posted was a very prescient piece of commentary, and it deserves a blog post to explore the topic it raised: The limitations of analytics.

The comment came from Mr. Tim Pappas (a VP at Gen Re), and I am grateful to him for raising this important topic. Here are the points he raises that this post will address:

• Without understanding the limitations of “superior analytics,” insurance companies can be putting their bottom line in great danger.
• The picture may not be quite as clear as the “high resolution” data provided indicates.
• The complexity of all the factors involved can lead to errors in estimation, making the computations imprecise and sometimes outright faulty.
• If the data is off on just a small percentage of risks, the impact on portfolio profitability can be quite large.