Insurance professionals and risk managers know well the typical areas of loss

Mother nature and our complex world continue to offer an ever growing list of associated risks that can unexpectedly occur, and while they are not always easy to predict, some solutions are clear.

The summer of 2004 generated 2.2 million claims and brought the names of hurricanes Charley, Frances, Ivan and Jeanne into the daily lexicon of residents of the southeastern United States. These names may not be as memorable in the future as Andrew or Camille, but their economic impact will be felt for years to come. While no one event was especially devastating, their combined temporal and spatial clustering was far from anticipated.

The relative likelihood of these types of storms is fairly frequent.

The return period of any one storm is estimated to be less than ten years - in other words, there is an estimated 10% chance that one of these storms could hit this general area in a year. The combined economic effect of all four storms has a return period of roughly 25 to 30 years, or a 3 to 4% chance that one season could see multiple events equal to the sum of these four hurricanes. A storm on the order of Hurricane Andrew is estimated to have a 75 to 125 year return period, or a 0.8 to 1.3% chance of occurring in one year.

The question remains: if 2004 was comprised of events with such probability of occurring, how much worse could it become? The area continues to reel from the enormous volume of claims, and many of the more complicated commercial claims are still unsettled after six months.

While catastrophe modelling can help predict the effect that an event would have in a given area, several other factors that are harder to anticipate can also come into play. The occurrence of multiple storms introduced many new issues for risk managers and insurance professionals. These events occurred during a relatively high housing boom for the entire United States, which did not allow for excess capacity, either in material or labour, to be shifted to the southeastern United States. Building materials and labour grew scarce, and outside intervention was required in many areas.

Those in need were willing to pay exorbitant rates to make their businesses or lives operational again.

Additional factors

The lack of availability of skilled contractors and scarcity of roofing shingles - the most basic of materials - also spawned improvisation, which may have consequences for future losses. Some consumers are now undertaking home improvements themselves but lack the skill and, frequently, the materials to perform the repairs properly. Used billboard material - a thick, vinyl product available in large sheets - is beginning to replace the tattered blue tarps that still dot the landscape of many parts of Florida. Local municipalities are struggling with issuing building permits and following up with diligent inspections. Poor quality workmanship may provide a temporary solution at the cost of undermining building performance during severe storms or hurricanes in 2005. To further complicate the situation, significant delays in repairing properties are causing exposure to the elements and additional risks, mould for example.

The 2004 hurricanes also came at a time of high oil prices. Petroleum dependent products, such as roofing material and paint, increased in value as the price of oil rose. In addition, the cost of transporting these weighty products drove prices higher. The financial impact of high oil prices, however, impacted more than just the construction industry. Hurricane Ivan occurred at particularly bad time for the offshore oil industry in the Gulf of Mexico off southeastern Louisiana. Most platforms temporarily halted the pumping of oil through the maze of underwater oil pipelines.

This temporary suspension has continued because of damage to the network by underwater landslides, which buried the damaged pipes and have made repairs in the soft silt sea bottom nearly impossible. The continued loss of production has caused significant loss to delivery contracts.

Risk managers in the energy industry must be diligent in monitoring the impact of failure to deliver product at times of high demand. Loss of market share can have an economic impact that lasts much longer than just the time it takes to rebuild a damaged property. Another lesson for offshore platforms is the risk to valuable pipeline (piping material, installation and transport value) overlaid on such vulnerable land. Such experience should be considered when a transport route requires access to key roads, bridges, tunnels or harbours that might be compromised after an event.

The 2004 tsunami

The horrific tsunami disaster of 26 December 2004, brought tremendous loss of life and property damage. Like the 2004 hurricane season, the loss may go far deeper than originally expected. The inundation of salt water into fertile fields may make them uncultivatable for decades, and the intrusion of salt water into the water table could make potable water inaccessible. This consequence should be considered for any area exposed to large volumes of airborne or liquid contaminants. Furthermore, haste to clean up damaged areas can lead to inappropriate disposal methods, such as open air burning or unsafe dumping of toxic materials.

Another major lesson from the tsunami is the need to prepare widespread early warning systems, which are relatively inexpensive. The tsunami also demonstrated the need to educate residents and employees about evacuation plans. Evacuation plans should be reviewed, with consideration given to the severity of the risk - shorter distances are required for smaller risks, while major events might necessitate a meeting place 20 miles away.

Plans for recovery are equally important. Although international post-event relief efforts may be assumed, countries must not reduce their efforts to create risk transfer systems for natural hazards. International relief agencies pledged long term aid after Hurricane Mitch in Honduras in 1998, but 20,000 people remained homeless three years later. After the devastating 2003 earthquake in Iran, the global community pledged $1 billion to aid efforts, but the Iranian government reports that it has received only $17 million to date.

Contract provisions

Insurance policies are major sources of recovery after an event, but the interpretations of policy provisions are far from consistent or well defined. The time it takes to resolve these terms can lead to further complications. Long after the terrorist attacks on September 11, 2001, the Deutsche Bank building opposite the World Trade Center site in New York remains shrouded due to disputes over the terms within insurance contracts. This lengthy delay has created a hazard so risky that it has been proposed that the massive structure should be demolished in a negative pressure environment instead of the open air removal process used for the World Trade Center. It remains to be determined who will bear this inordinate cost.

Insurance carriers are faced with significant unknowns when they issue a policy. One of these is the way regulators may intervene after an event to modify the definition of the contract. Several insurers have accepted such changes in order to maintain positive regulatory relationships and provide goodwill to their customers. Examples include relaxing application of deductibles or forgoing premium during times of crisis. Regulators also can impose fines for improper reporting of claims information. Insurers also need to establish whether their reinsurers will follow the same decision or decide to litigate.

Catastrophe risk management software assists with quantifying loss associated with hurricanes, earthquake, tornado, hail, winter storm or terrorist acts. However, although these models improve with each newly released version, they are unable to quantify adequately the complex interactions of today's society. Commercial insurance policies often provide protection for interruption to business due to unforeseen events, such as the loss of power when transmission lines are destroyed or intentionally shut off by law enforcement. Far more complex provisions may be necessary if a catastrophe affects a supplier's production, so triggering a loss. Complex contingent business interruption coverage can be very difficult to quantify.

Risk managers and insurers should exercise caution when considering how dependent an operation is on outside suppliers.

Planning ahead

The infrequent nature of catastrophic events makes individuals complacent about risk mitigation. Our memories fade all too quickly, and our reactions can be impaired. Regular review of risks and risk management measures will pay significant dividends post-event. Guy Carpenter's worldwide headquarters were destroyed by the September 11, 2001 terrorist attacks, yet a rigorous disaster recovery plan allowed everyone to be operational within hours, with all staff back to a desk within days. Catastrophic events can introduce significant risks that have not been previously contemplated, but a resilient risk management strategy can remove some of the unknowns. We need to spend time with business colleagues, and on a personal level with family members, to consider what can go wrong and develop strategies to mitigate the loss.

By preparing for the worst and heeding lessons of previous events, even severe storms can be weathered.

- John Tedeschi is an actuaryand managing director of Guy Carpenter & Company.


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