The Risks of Hazard

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). 

Have you heard it’s raining in California? Los Angeles has broken precipitation records for July, and there have been flash floods throughout southern California and Arizona. The Angels even had a ball game rained out for the first time in over 20 years. The moisture has helped with the drought and a bad wildfire season, but it has added to the headaches of property insurers writing in California. Weather from the west coast is regularly newsworthy, but this past week has been extraordinary. How weird has it been? It even snowed in the Sierra Nevada this week.

One of the most devastating forms of flood risk is coastal storm surge. The flooding is most intense at the shoreline, but surge flooding can affect locations 40 miles (65 km) from the coast. The amount of storm surge is dependent upon the size of the storm creating the surge, and the tide at the time of the surge. As building codes have improved, most damage caused by hurricanes is now due to the flooding associated with them — not wind damage. Some of the most devastating and expensive natural disasters in the USA have been largely due to storm surge, including Sandy and Katrina.

Now that 2014 is far enough in the past, we can read summaries about the natural catastrophes that affected global insurance. Let’s explore some of the more interesting facts from last year regarding insured losses.

First of all, it was a very quiet year for natural catastrophes. There was no major event that will define the year 2014, unlike 2011 (Thailand Floods, Tohuku), 2013 (Sandy), or of course 2005 (Katrina). In fact, no event was close to the Top 40 events of the past 45 years in terms of insured losses. As is usual when there is no major hurricane or earthquake, convective storm was the natural peril that caused the most damage to insured property.

This final blog post introducing earthquake risk and analytics explores a common accompaniment to earthquake: tsunami. This is an interesting peril because it's actually a combination of two perils — earthquake and flood. Tsunami is the surging flood from the ocean caused by sudden seabed vertical displacement (or, rarely, it can be caused by a huge landslide). The earthquake may or may not cause damage on a nearby coast, but the huge volume of water hitting coastal areas at high velocity causes intense damage — frequently complete destruction.