If “there’s squalls out on the gulf stream, a big storm’s coming soon.” In his 1974 opus “Trying to Reason with Hurricane Season,” Jimmy Buffett told the insurance buying public all they need to know about a damaging storm’s impending landfall. If only it were this simple.
In 2003, Risk Management Solutions (RMS) took a stab at predicting catastrophic windstorm damage with a major revision to its North Atlantic hurricane model. In subsequent years, revisions to that model followed. But a major update released in late February has brokers asking if this, coupled with recent events in Japan, will prove a catalyst in hardening the seemingly perpetual soft market.
The marketplace knew it was coming. RMS put out the word of its impending release of version 11.0 almost a year ago.
“RMS sends out advanced versions of its revisions for carriers to review and test as well as to help manage outcome and help set strategy for implementation,” says Jim Sipich, a property broker out of Crump’s San Francisco office. “This helps relieve some of the shock to the market when it is actually released.”
Brokers are concerned with how the model update may affect pricing given increased annual average loss estimates based on data in already high-risk areas like Florida and Texas. While some coastal regions may actually show decreases in projected losses because of more stringent building codes, this is not the case in all coastal regions. Another major concern is that any gains in such high-risk areas will be negated by increased loss projections across inland counties. For example, projection increases by as much as 50% in Florida and more than 90% in Texas.
“Severity is a powerful measure of solvency. Historically, model revisions are introduced in the wake of a disaster. With this model we tried to stay ahead.”Tweet
In its latest revision, the RMS model indicates that a greater expanse of inland areas suffer much more damage from hurricanes then previously believed, in part because of lax building standards and evidence of roof damage at relatively low wind speeds.
Brokers agreed that it will take some time to see the extent to which the model will affect the marketplace.
“I expect most [carriers] will implement the new model to some degree over the next year,” Sipich says. “The truth is that no carrier wants to be the first to hit the marketplace with new underwriting or pricing data in response to a major model revision like this.”
“Carriers are still analyzing the impact of the model on their portfolio and pricing models,” says Adam Kagan, chief of marketing relations for Crump. “As a carrier, you go to bed thinking the exposure is ‘x.’ You wake up the next day to see a model revision that indicates it’s actually ‘y.’ If ‘y’ yields greater exposure and increased premium requirements, what is the carrier supposed to do?”
Model revisions have other effects. “While it’s true that underwriting guidelines may be affected by model changes, the major effect models can have on the marketplace has to do with capacity carriers have and how they choose to use it,” says Rich McElreath, a Crump property broker. “Not just net capacity, but also capacity from their treaty reinsurers.”
“Instead of offering $10 million, maybe now [the offer from insurers or reinsurers] will be $5 million,” Kagan says. “It also affects attachment points, i.e., primary vs. excess.”
Kagan is also concerned about how rating agencies will respond to the RMS revision. “Rating agencies use model results to assist in analyzing a market’s financial position and support rating analysis,” he says.
A model’s effect on the insurance industry is “more about capital requirements than underwriting,” says Dr. Claire Souch, RMS vice president. In terms of losses, the model’s main focus is severity, not frequency, she says. “Severity is a powerful measure of solvency,” she says. “Historically, model revisions are introduced in the wake of a disaster. With this model we tried to stay ahead.”
While she acknowledges that the industry does not typically just “take the model and incorporate it overnight,” she believes the data will affect the marketplace this year.
It’s early, and brokers are still reviewing the impact. “Treaty reinsurance costs, specific impact of the changes on carriers’ portfolios as well as the basic economic principle of supply and demand will all contribute to potential changes in the marketplace,” says Kagan. “Some insureds may feel more of an immediate impact than others, and it really is a case of ‘stay tuned.’”
Kagan and other brokers stopped short of saying yes when asked if carriers historically use revised model data as a crutch to raise premiums. “Ultimately, the model is a tool,” he says. “Would I be shocked if some carriers used it to justify hardening the market and raise prices? No,” he says. “Will the entire marketplace accept it and follow the changes? We’ll have to wait and see.”