All posts by James Lynch

Hurricane insurance in one chart

Hurricane season doesn’t start for another couple of months, but recently, I.I.I. requested a chart showing the sum of all catastrophe losses since 1980, broken down by state. Insurance Services Office obliged with data from its Property Claims Services Unit. The results may surprise you:

iso cat loss chart_2 3 26

In all, insurers have paid out nearly $380 billion in catastrophe losses (adjusted for inflation to present day dollars). Three states – Florida, Texas and Louisiana – make up more than a third of that number – driven largely by hurricanes.

This spring, a nasty flood forecast

With spring here and the snow melting, flood season arrives.

The melt-off promises to be a nasty one.

“For the third consecutive year, the stage is set for potential widespread, record flooding in the North Central United States,” said Jack Hayes, director of the National Weather Service.

The North Central snow pack contains more water now than snow pack in the past 60 years. The Environment News Service surveys the gloom:

The highest spring flood risk areas include the Red River of the North, which forms the state line between eastern North Dakota and northwest Minnesota.

Risks are also high along the Milk River in eastern Montana and along the James and Big Sioux Rivers in South Dakota.

The weather service is also warning about flood risks along the Minnesota River and throughout the upper Mississippi River basin from Minneapolis, Minnesota southward to St. Louis, Missouri.

Floods will inundate portions of lower New York, eastern Pennsylvania and northern New Jersey, according to the weather service.

The story links to this National Weather Service site, which lets you see the status of 4,779 river gauges across the country. I took this screen grab of the 14 gauges where major flooding was occurring Wednesday morning:

Wednesday's flooding
Wednesday's flooding

The site lets you drill down, so I can tell you the flooding is near East Stump Lake, ND; the James and Big Sioux rivers in southeast SD; the Cottonwood River near New Ulm, MN; the Ohio River near Paducah, KY; and the Mississippi near Osceola, AR.

This I.I.I. video discusses the basics of flood insurance, including the most important fact: The standard homeowners policy does not cover flood.

Insurance agents sell flood coverage, but in almost every case the federal government bears the risk through the National Flood Insurance Program, usually referred to at the NFIP. Details here, including a cool interactive device that lets you estimate how expensive flood damage can be. A six-inch flood in a 2,000-square-foot home will set you back $39,150, with the cost of flooring the biggest chunk of that, at $15,870.

Also note that flood coverage doesn’t take effect until 30 days after you have gotten it. That’s to prevent people from binding coverage as they canoe out their front door – a guaranteed money-loser if you are the insurer.

And NFIP has enough to contend with. Losses from Katrina and the other 2004-2005 hurricanes left the program with $18 billion of debt. The debt contributed to Congress’ difficulty reauthorizing the program last year. It expired – temporarily – several times, disrupting home buying. (Banks like to see flood insurance before lending in low-lying areas.)

The program is authorized through September, certainly enough for spring flood season. Two weeks ago, Congress held hearings on a restructure to keep the program going another five years. “There’s no question the program is in dire need of reform,” Republican Rep. Judy Biggert told Reuters. The NFIP “continues to be financially unstable.” One of her key goals will be to “eliminate taxpayer risk” through pricing the risk closer to the actual exposure.

Covering the links broken in Japan’s supply chain

Estimates of the insured loss from the Japanese earthquake and tsunami continue to roll in. They range from $12 billion (Eqecat’s low estimate) to $60 billion (London insurance analyst Barrie Cornes). Mainichi (Japan) Daily News gives a roundup.

But one of the big unknowns for insurers is what the total loss will be from various types of business interruption coverage. As I.I.I. explains, “Business interruption insurance compensates you for lost income if your company has to vacate the premises due to disaster-related damage that is covered under your property insurance policy, such as a fire.”

That sounds simple, but it can be an enormous portion of claims after a disaster. Business interruption constituted about a third of all losses from the 9/11 terrorist attacks. Eqecat, a catastrophe modeling firm, estimated that business interruption losses would be about 20% of its Japan estimate, as the coverage is less common in Japan than in the United States.

Another type of coverage, contingent business interruption, presents a trickier wrinkle. Contingent business interruption reimburses lost profits and extra expenses when the premises of a customer or supplier suffers an interruption of business.

So a business with contingent business interruption coverage might have a claim if it depends on a Japanese supplier whose operation is shut down. And if the business has to turn to a new, more expensive supplier, the extra cost might be covered under extra expenses coverage.

A web page produced by the International Risk Management Institute (IRMI) explains details, such as:

  • Insureds can get protection against a set list of suppliers or purchase blanket coverage protecting any supplier’s shutdown.
  • The claim must be of a type that would be covered under the insured’s own policy.
  • Usually there is a time deductible (48 or 72 hours, for example). That period must expire before an insured can receive reimbursement.

The coverage is designed to protect against a prolonged interruption of the supply chain. For example, last week the Wall Street Journal reported that ON Semiconductor, out of Phoenix, Ariz, is working with insurers regarding coverage under business interruption and “supply chain disruption.”

It’s quite difficult to know how much the contingent business interruption claims will total, since a contingent business interruption claim could be filed by a company anywhere in the world. For that reason, catastrophe modelers like Eqecat don’t include contingent business interruption claims in their estimates.

Some in the industry indicate that the losses won’t be a big part of the losses from the Japan disasters. One insurance coverage attorney told the Journal that a business that itself lacks earthquake insurance might not be able to claim on its contingent business interruption. Remember, a company can only claim for a loss that would have been covered had its own property sustained it. An expert with the brokerage Aon Benfield said the claims aren’t something that “moves the needle in the insurance industry.”

And the New York Times notes that Japan’s importance in some industries, like semiconductor manufacturing, has waned in recent years as countries like South Korea, Taiwan, and China have gained market share.

I.I.I. continues to update its web page covering the Japan disasters.

Millions saved in Japan by good engineering and government building codes

As the devastation in Japan achingly unfolds, it’s easy to learn about the thousands of deaths, the piles of debris, the washed-away homes and think, “Nothing could be worse.”

But that’s not the case.

Of course, the toll is both enormous and tragic. Thousands are dead. Economists estimate the economic losses between $50 billion and $150 billion. (Insurance losses will be less, since not everything that gets damaged is insured.)

It could have been so much worse. The building codes and warning programs in place saved thousands of people and billions of dollars.

Japan enjoys some of the world’s strongest building codes to minimize the earthquake threat and has continued to strengthen them after each event.   The New York Times examined the issue shortly after the earthquake:

In Japan, where earthquakes are far more common than they are in the United States, the building codes have long been much more stringent on specific matters like how much a building may sway during a quake.

After the Kobe earthquake in 1995, which killed about 6,000 people and injured 26,000, Japan also put enormous resources into new research on protecting structures, as well as retrofitting the country’s older and more vulnerable structures. Japan has spent billions of dollars developing the most advanced technology against earthquakes and tsunamis.

Japan has gone much further than the United States in outfitting new buildings with advanced devices called base isolation pads and energy dissipation units to dampen the ground’s shaking during an earthquake.

The isolation devices are essentially giant rubber-and-steel pads that are installed at the very bottom of the excavation for a building, which then simply sits on top of the pads. The dissipation units are built into a building’s structural skeleton. They are hydraulic cylinders that elongate and contract as the building sways, sapping the motion of energy.

The Times article, written last week, also emphasized tsunami protections like regular training drills and sea walls. The swamping of Sendai makes it unclear how well those worked, but in some cases, the tsunami moved so rapidly, people had little chance to escape.

In some towns, the first waves struck within a half-hour of the earthquake, as this Wikipedia entry documents. And one standard piece of advice – get above the wave – didn’t work in towns where the high point was a building that washed away.

But the building codes seem to have done their job in the face of the largest earthquake in Japan’s long history. Although the damage is extensive, it is a far cry from the destruction last year in Haiti, where poor construction increased the death toll. The country also fared better than China did after the Sichuan earthquake in 2008. There, building codes were strong, but enforcement was lax.

Even with the post-Kobe improvements, there will be a lot of lessons coming from this month’s earthquakes, including how to protect nuclear reactors from the twin threats of earthquake and tsunami.

In the United States, the insurance industry makes sure building codes are enforced through the Building Codes Effectiveness Grading System, a job performed by the Insurance Services Office. The system got its start after Hurricane Andrew in 1992, when it became clear that Miami’s vaunted hurricane codes were spottily enforced. Buildings in highly rated areas are eligible for insurance discounts.

Meanwhile, Reuters notes that in California, newer buildings can withstand mighty quakes, but if one happens, “the surviving buildings will tower over a carpet of rubble from older structures that have collapsed.” The issue, according to Reuters: California has been lax in retrofitting older buildings.

Retrofitting was also an issue in the recent New Zealand earthquake. Recall most of the startling images – the steeple toppled from Christchurch Cathedral, for example – were older buildings in need of retrofit. In 2004, New Zealand authorities required old buildings to have one-third of the resilience of newer ones, but gave the requirement 20 years to take effect, the Wall Street Journal reported early this month.

I.I.I. continues to update its web page covering the Japan quake.

In Japan, the public bears most of the risk of earthquakes

The devastation unfolding in Japan will likely generate the largest insured losses for any earthquake, but by far the biggest part of the tab will fall on the Japanese people.

Less than half of residences in the country carry earthquake insurance, according to the 2010 Annual Report of the Japan Earthquake Reinsurance Co. (A pdf in English is available here.)Â   The company, usually called the JER, protects all residences that purchase earthquake insurance.

The standard dwelling policy in Japan does not cover earthquake, but customers can choose to add the coverage. But earthquake insurance covers only up to half the losses that a standard residential policy does.

So a home that is covered for fire losses of, say,  ¥20 million (US$245,000), only has  ¥10 million (US$122,000) cover for earthquake. (Earthquake cover includes tsunami and fires caused by the earthquake.) Personal property coverage is similarly pro-rated.

Claimants recover 5%, 50% or 100% of the earthquake limit, depending on whether the loss is considered a partial loss, a half loss or a total loss. Early reports showed partial losses far outnumbering the other types, but claims are continuing to come in.

Japanese companies offer earthquake cover, but the premium – determined by zone by the Non-Life Insurance Rating Organization of Japan – is routed to the JER. To protect itself, the JER purchases its own reinsurance. JER’s main reinsurer is the Japanese government, but private reinsurers are also involved.

The highest payout the JER contemplates is  ¥5.5 trillion, or $67 billion. That’s well above early estimates of the insured loss, which top out at $35 billion, according to the cat modeling firm of AIR. AIR’s estimate excludes tsunami losses but includes losses to commercial buildings, which are not reinsured by the JER.

Should the maximum loss occur, JER is responsible for the first $1.4 billion. Of the next $65 billion, the Japanese government, would pay around 80%, with private insurers and the JER roughly splitting the rest.

If the loss exceeds JER’s  ¥5.5 trillion limit, the company could pro-rate its payments downward.

I.I.I. is continually updating its web page devoted to the disaster.

Earthquake strikes Japan, triggers tsunami

The tragic earthquake and tsunami that hit Japan earlier today have unleashed a rapidly unfolding catastrophe, as the tsunami crosses the Pacific and as casualty and damage reports mount. The basics, via the U.S. Geological Survey, which monitors earthquake activity worldwide:

  • Magnitude: 8.9 – the largest earthquake since the Chilean earthquake last year, which registered 8.8. Last month’s quake in New Zealand registered 6.3.
  • Date/time: Friday, March 11 at 2:46 p.m. local time. (12:46 a.m. Eastern Standard Time)
  • Depth: 15.2 miles. Shallower earthquakes cause more damage. Last year’s Chilean quake was 22 miles down. The New Zealand quake was   shallow, just 3 miles underground.
  • Location: 38.322Â °N 142.369Â °E – 80 miles east of Sendai, Japan and 231 miles northeast of Tokyo.

I.I.I. has assembled a presentation and a web page on the earthquake and its potential impact on the insurance market. I.I.I. has more information on earthquakes and tsunamis here.

Teen Drivers: Put. The. Phone. Down.

I first got interested in distracted driving one sunny morning when my bored children started counting the number of drivers texting on the New Jersey Turnpike.

They only got to seven or eight, but traffic was light, and it was the New Jersey Turnpike, for crying out loud, so all those texters were going something like 70 miles an hour – unless they were in a hurry.

The risks these drivers were taking shocked me, but I’m behind the times. Two-thirds of Americans surveyed by Consumer Reports National Research Center had seen a driver texting within the past 30 days.

Teen-agers, glued to their media as they seem to be, are an even greater risk. In the survey, younger drivers were less likely to see texting or talking on cellphones while behind the wheel as a danger. Sixty-three percent acknowledged talking on a cellphone while driving, while 30 percent said they had texted.

So, as the Washington Post reports, the U.S. Department of Transportation and Consumer Reports have teamed up to get teen drivers to put their phones down.

Consumers Union has devoted a chunk of its famous April car-buying issue to the distracted-motorist phenomenon, including product reviews of devices meant to address the problem.

The government’s web site devoted to the overall problem, distraction.gov, features videos of young drivers dead because of distracted driving, including this one about the brother of Loren Vaillancourt, Miss South Dakota:

The web site also has a brochure (pdf) directed at parents and educators. Its tips include: Talk to your teen, set ground rules, sign a pledge, educate yourself and spread the word.

But the first tip is: Set a good example – something I hope my kids can see next time we’re on the Turnpike.

I.I.I. has more information on the problem here.

EU bans gender-based insurance rates

In most of the United States, men pay more for auto insurance than women do, and with good reason: Men cost more to insure – especially young men.

The same was true in much of Europe, until last week.

Male drivers didn’t get any better. But the European Court of Justice banned gender-based insurance rates, saying they were incompatible with Europe’s Fundamental Charter of Rights. That document prohibits “any discrimination based on any ground such as sex, race, colour, ethnic or social origin, genetic features, language, religion or belief, political or any other opinion, membership of a national minority, property, birth, disability, age or sexual orientation.”

In the past, insurers relied on a 2004 directive that recognized the strength of the evidence for gender-based rates. The average claim for an 18-year-old male in the U.K. totals  £4,400 ($7,160), vs.  £2,700 ($4,390) for an 18-year-old female.

The net effect: Women will be subsidizing men for auto insurance. One British insurer estimated that women under 25 years could pay 25% more per year – perhaps  £400 ($650).

The ruling affects other types of insurance, too. Women live longer, so they traditionally paid lower rates for life insurance. (The insurer could earn more investment income off the premium while waiting for the woman’s demise.) So women will see life insurance rates rise, perhaps by 20%.

Women will benefit, though, with annuities. Now, women receive lower payouts than men, as they live longer in retirement.

All this was analyzed by the Association of British Insurers (ABI) well before last week’s ruling. (A pdf is here.)

Overall, rates could end up higher than they are now. As the ABI notes, the ruling creates uncertainty, and the less certain the environment, the more insurers are likely to charge.

That will be tough to take in the U.K., where the average auto insurance rate has almost doubled in the past three years, to  £1,332 ($2,167), according to the Independent.

In the U.S. personal auto market, sex “is still taken into account as part of complex formulas,” and plays a big role with younger drivers in particular, a public policy specialist at the National Association of Mutual Insurance Companies told the Wall Street Journal. But it has become less important as insurers have begun turning to credit scores to help peg rates.

Of course, credit scores are not without controversy, an issue I.I.I. has explored frequently.

The ruling takes effect in December 2012.

No D&O at Berkshire Hathaway

Warren Buffett created a bit of a stir last week when he acknowledged in his folksy annual letter to shareholders that the company he built, Berkshire Hathaway, does not purchase directors and officers insurance for its directors.

D&O insurance protects top management in case of negligent acts or or misleading statements that cause the company to be sued. (I.I.I. explores the basics of D&O here.)

In the letter, the Sage of Omaha said the lack of insurance helped “the directors who represent you think and act like owners.”

They receive token compensation: no options, no restricted stock and, for that matter, virtually no cash.   .   .   . If they mess up with your money, they will lose their money as well.   .   .   . Our directors, therefore, monitor Berkshire’s actions and results with keen interest and an owner’s eye.

The insurance trade press perked up, with both Business Insurance and Insurance Journal headlining the fact that Berkshire’s directors “go bare.” That’s in no small part because Berkshire is a significant player in insurance (GEICO) and reinsurance (National Indemnity and General Re). Nearly 40 percent of $19 billion in before-tax income last year came from insurance.

At D&O Diary, though, Kevin LaCroix was less impressed:

Though Buffett highlights this approach to D&O insurance as a corporate strength, don’t expect this practice to catch on widely. No other company can offer an indemnification commitment as substantial as Berkshire’s. Nor could any insurer make an insurance commitment as financially substantial as Berkshire’s indemnification undertaking. Buffett’s views on D&O insurance reflect a unique set of circumstances.

I asked Kevin about this, so he explained further in an email:

D&O insurance provides companies a way to finance their indemnification obligations and to meet those obligations if the company becomes insolvent. Berkshire is certainly not going to become insolvent, and it has no need to resort to third party financing of its indemnification obligations. Moreover, any third party to which it might resort to finance that obligation would be less well capitalized that Berkshire, so the transaction wouldn’t even make economic sense.

In other words, Berkshire is big enough to self-insure any D&O claims that may come its way.

The Wall Street Journal wraps up reaction to Warren’s letter.

Earthquake insurance: Effective when purchased

New Zealand’s earthquake last week occurred almost exactly a year after a massive quake struck near Valparaiso Concepcion, Chile. The anniversary of the latter prompted Aon to publish a retrospective, all of which points up the importance of having earthquake insurance. (h/t Risk Market News)

Both were major events, with the cat modeling firm AIR estimating New Zealand’s losses between $3.5 billion and $8 billion. Losses from the Chilean quake top $8 billion, according to Aon.

Despite significant losses from the quake, the Aon report pointed to important successes in the aftermath of the Chilean event. The insurance system worked effectively. No insurers faced insolvency or bankruptcy. Claims have been handled efficiently – 95 percent of residential claims and 80 percent of commercial claims have been settled. Reinsurers – which sell protection so insurers can hedge their risk – filled their role well.

But challenges remain. Many personal-lines claimants did not understand their policies had deductibles. The sheer volume of claims (nearly 250,000) created bottlenecks, especially since government regulations require registered claims adjusters. There were issues in which different policies had overlapping coverage. And the market lacks a standard policy, complicating the settlement of claims.

Aon also praised the regulatory environment. Regulators require insurers to track their earthquake exposure and purchase reinsurance accordingly, which in this case helped guarantee that insurers could meet their obligations.

And lenders require earthquake insurance on mortgaged property. As a result, 24 percent of residential properties have earthquake insurance. That’s less than New Zealand, where all residential insurance policies include a surcharge for up to $100,000 coverage (in New Zealand dollars – about $75,000 U.S.) in the goverment’s earthquake pool. But it’s twice the take-up rate seen in California.

Last year, a I.I.I. white paper on the state risk pool, the California Earthquake Authority, noted “the percentage of policyholders buying the coverage appears to rise and fall depending on how long ago the last significant earthquake occurred.” In 1996, about one-third of residential policies in the state purchased earthquake cover. Today, 12 percent do.

The out-of-sight, out-of-mind problem isn’t unique to California. Last week, Missouri’s Department of Insurance noted similar drop-offs in St. Louis and counties near the New Madrid fault, site of several massive earthquakes 200 years ago. I’ve put all the information into a chart:

take up rates_4

I got information on California’s take-up rate here.

You can see that California’s take-up rate is considerably lower than the selected Missouri locations. But all of them are declining.

Meanwhile, Missouri’s neighbor to the south, Arkansas, had two sets of widely felt earthquakes in February, according to the U.S. Geological Survey, and California had a notable shake Jan. 8. Thankfully, all were minor.