The Risks of Hazard

This blog post is part 2 of 2 exploring how underwriting leakage  manifests itself in the property insurance market. On Tuesday it was rate fluctuations after a catastrophic event. Today, we look at the coverage gap.

To recap briefly, underwriting leakage is the difference between perfection and reality when an underwriter assigns financial conditions on risk. Ideally, there is no difference, but in reality there is always a difference.

The coverage gap is the difference between total economic losses from an event and insured losses. It can be caused by a lack of insurance penetration into a market, a lack of suitable products available, or certain coverages missing from the available products. Here is a recent paper on the coverage gap from Swiss Re (they call it the “protection gap”, but it’s the same thing) that explains it much better. In a perfect world there would be no coverage gap because all the necessary policies would be available at the right price, offering the right coverage. This is the perfect world where there is no underwriting leakage.

The assignment of a price to a risk is the core activity of insurance, and underwriting is the fulcrum on which risk and money balance. Any difference between perfection and reality in that balancing act is called underwriting leakage. Let’s explore two results of that leakage:

1. Premiums become volatile after a natural catastrophe event
2. A coverage gap in the risk pool occurs

1. Volatile Premiums

Underwriting leakage for natural catastrophes becomes obvious after a bunch of claims are paid: prices go up within a year or two. While these premium increases are considered a necessity by insurers, it is a source of frustration to consumers and anxiety to regulators. Consumers don’t like premium rises, and regulators don’t like unpredictable pricing because they don’t like unhappy consumers (i.e. voters). 

The annual conference for the National Association of Professional Surplus Lines Offices (NAPSLO) was last week in San Diego, and Intermap’s Catherine Stinson was there. It was our first trip to NAPSLO, and it was exciting to hear from Catherine that the concerns we address with location-based analytics for underwriting are concerns of conference attendees. She caught up with several attendees, in what was a very busy couple days for all. In fact, it sounds like intense business discussions went late into the night for some.

The Associated Press recently ran a story on new research that tries to ascertain the return period (or annual likelihood) of the 2013 Colorado floods. Here is a reminder from the Denver Post of what the flood was like; since it was over two years ago (it seems like yesterday!).

As any decent summary should, let’s start with the conclusion of the research: “…the best way to characterize this storm is a very unusually widespread 100-year event with some small pockets of a 500-year event thrown in there.”

A very unusually widespread event? A 100-year event, except where it was a 500-year event?

Last week I compared hurricane history with the current (at the time) forecast. There were a few storms of potential interest, including Erika and Ignacio. Well, here’s what really happened: