The challeges of catastrophe loss management post-katrina. Climate change and extreme weather. Catastrophe and disaster modeling post-katrina

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1 Concluding remarks Catastrophe Loss Management in an Era of Climate Change An Insurance Industry Perspective Urban Leaders Initiative, Center for Clean Air Policy Dr L James Valverde, Jr Vice President, Economics and Risk Management Insurance Information Institute 110 William Street New York, NY Tel: (212) Fax: (212) jamesv@iii.org 4 December 2006 Presentation Outline The challeges of catastrophe loss management post-katrina Climate change and extreme weather Catastrophe and disaster modeling post-katrina P/C industry resilience to extreme weather

2 Catastrophe Loss Management Post-Katrina Top 10 Deadliest Hurricanes to Strike the US: ,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 LA-Grande Isle (1909) Audrey-SW LA,TX (1957) Hurricane Katrina was the deadliest hurricane to strike the US since 1928 LA-Last Island (1856) FL Keys (1935) 700 GA/SC (1881) LA-Cheniere (1893)***** 1,250 1,300 1,500 Katrina (SE LA, MS)**** SC/GA Sea Islands (1893)*** 2,500 SE FL/L. Okechobee (1928)** 8,000 Galvaston (1900)* *Could be as high as 12,000 **Could be as high as 3,000 ***Midpoint of 1,000 2,000 range

3 $ Billions $45 $40 $35 $30 $25 $20 $15 $10 $5 $0 Hurricane Jeanne (2004) $3.7 $4.6 $4.7 Hurricane Frances (2004) Eight of the 11 most expensive disasters is US history occurred within the past 4 years Hurricane Rita (2005)* Hurricane Wilma (2005)* $6.1 $6.4 $7.1 $7.5 Hurricane Hugo (1989) Hurricane Ivan (2004) Hurricane Charley (2004) $15.9 Sept. 11 Terror Attack (2001) Northridge Earthquake (1994) $20.1 $20.8 Hurricane Andrew (1992) $40.0 Hurricane Katrina (2005)* *Stated in 2005 dollars. Note: 9/11 loss figure is for property claims only. Total insured losses ($2004) are approximately $34B. Sources: ISO/PCS; Insurance Information Institute. Top 10 Most Costly Hurricanes in US History, (Insured Losses, $2005) $45 $40 $35 $30 Seven of the 10 most expensive hurricanes in US history occurred in the 14 months from Aug Oct. 2005: $40.6 $ Billions $25 $20 $15 $10 $5 Katrina, Rita, Wilma, Charley, Ivan, Frances & Jeanne $3.5 $3.8 $4.8 $5.0 $6.6 $7.4 $7.7 $10.3 $21.6 $0 Georges (1998) Jeanne (2004) Frances (2004) Rita (2005) Hugo (1989) Ivan (2004) Charley (2004) Wilma (2005) Andrew (1992) Katrina (2005)

4 $ Billions $45 $40 $35 $30 $25 $20 $15 $10 $5 $0 Hurricane Wilma (2005)* $6.1 $6.4 $6.6 $6.6 $7.8 $8.0 Hurricane Hugo (1989) Five of the 11 most expensive disasters is world history affected the US within the past 4 years. Windstorm Lothar (1999) Windstorm Daria (1990) Typhoon Mireille (1991) Hurricane Charley (2004) $11.0 Hurricane Ivan (2004) $15.9 Sept. 11 Terror Attack (2001) Northridge Earthquake (1994) $20.0 $21.5 Hurricane Andrew (1992) $40.0 Hurricane Katrina (2005)* *All figures are for total losses across all locations, not just U.S. Katrina losses are a preliminary I.I.I. estimate. Katrina, Rita and Wilma losses stated in 2005 dollars. Sources: ISO/PCS; Swiss Re, Natural Catastrophes and Man-Made Disasters in 2003, Sigma, no.1, Global Number of Catastrophic Events, The number of natural and man-made catastrophes has been increasing on a global scale for 20 years Record 248 manmade CATs & record 149 natural CATs in Natural catastrophes Man-made disasters

5 $120 $100 $80 $60 $40 $20 $0 $7.5 $2.7 $4.7 $ Billions 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. $100B CAT year looms on the horizon $22.9 $5.5 $16.9 $8.3 $7.4 $2.6 $10.1 $8.3 $4.6 $26.5 $5.9 $12.9 $ ** 20?? $61.8 $6.2 $100.0 *Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. ** As of Sept. 30, Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B. Source: Property Claims Service/ISO; Insurance Information Institute Climate Change and Extreme Weather

6 Insurance in an era of global climate change is, in essence, a dual gamble In the first instance, the gamble is one that sees insurers and reinsurers engaged in the process of making a series of (partially) informed bets on the potential frequency, severity, and consequences of natural catastrophe events a task that is, in itself, fraught with uncertainty In the second instance, though, global climate change holds the potential to, in effect, confound our current understanding of the causes and consequences of extreme weather events If this portion of the dual gamble yields unfavorable outcomes for insurers, then it may signal the need for potentially drastic shifts in the way these risks are construed, assessed, and managed Is There a Connection? The destructive hurricane seasons of 2004 and 2005 in the U.S. have left many within the insurance and reinsurance industries openly questioning whether the observed increases in the number of tropical storms and hurricanes in the North Atlantic might, in some way, be linked to anthropogenically induced climate change The science of climate change offers little in the way of clear and definitive answers to many of the most pressing issues facing public and private stakeholders who share a mutual interest in, and concern for, issues pertaining to global environmental change For insurers and reinsurers, a key question is this: Will the frequency or the intensity of future tropical cyclone activity be measurably enhanced in a GHG-warmed world?

7 2005 set a new record for the number of hurricanes and tropical storms at 26, breaking 1930s mid-1960s: Period of Intense Tropical Cyclone Activity Mid-1990s 2030s? New Period of Intense Tropical Cyclone Activity Tropical cyclone activity in the mid-1990s entered the active phase of the multi-decadal signal that could last into the 2030s Already as many major storms in as in all of the 1990s s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s *Figure for 2000s is extrapolated based on data for (6 major storms: Charley, Ivan, Jeanne (2004) and Katrina, Rita, Wilma (2005)). Source: Tillinghast from National Hurricane Center: Was Been a Busy, Destructive, Deadly, and Expensive Hurricane Season All 21 names were used for the first time ever, so Greek letters were used for the final 5 storms: Alpha though Epsilon

8 What a difference a year makes! Just 9 named storms during the 2006 season compared to 28 in No US hurricane landfalls. Source: WeatherUnderground.com, October 20, Hurricane Season: Forecasts Repeatedly Scaled Back Named Storms % Year Average* Named Storms 275% hurricane seasons has turned out to be far less severe than anticipated 195% Actual May 31 Forecast Net Tropical Cyclone Activity 140% 15 August 3 Forecast 90% 13 September 1 Forecast 300% 250% 200% 150% 100% 50% 0% Net Tropical Cyclone Activity

9 $0 $500 $1,000 $1,500 $2,000 $2,500 Is Anyplace Safe? Total Value of Insured Coastal Exposure (2004, $ Billions) Florida New York Texas Massachusetts New Jersey Connecticut Louisiana S. Carolina Virginia Maine North Carolina Alabama Georgia Delaware New Hampshire Mississippi Rhode Island Maryland $740.0 $662.4 $505.8 $404.9 $209.3 $148.8 $129.7 $117.2 $105.3 $75.9 $73.0 $46.4 $45.6 $44.7 $43.8 $12.1 $1,937.3 $1,901.6 Florida & New York lead the way for insured coastal property at more than $1.9 trillion each

10 New York Florida Texas Massachusetts New Jersey Connecticut Louisiana S. Carolina Virginia Maine North Carolina Georgia Alabama Mississippi New Hampshire Delaware Rhode Island Maryland $437.8 $355.8 $258.4 $199.4 $121.3 $83.7 $69.7 $52.6 $45.3 $43.3 $39.4 $23.8 $20.9 $19.9 $17.9 $6.7 $994.8 $1,389.6 Commercial property exposure also implies significant business interruption losses Source: AIR $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, ¹ Wind/Hail/Flood 5 2.8% Earthquakes 4 6.7% Winter Storms 7.8% Terrorism 7.7% Civil Disorders 0.4% Fire 6 2.3% Water Damage 0.1% Utility Disruption 0.1% Tornadoes % Insured disaster losses totaled $289.1 billion from (in 2005 dollars). Tropical systems accounted for nearly half of all CAT losses from , up from 27.1% from All Tropical Cyclones % 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2005 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in Adjusted for inflation by the III. 2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood

11 Catastrophe/Disaster Modeling Post-Katrina Challenges for P/C Insurers: Uncertainty of Losses Natural disasters pose vexing challenges for insurers because they involve potentially high losses that are characterized by large degrees of uncertainty. Moreover, natural disasters involve spatially correlated losses or the simultaneous occurrence of many losses from a single event. Clearly, there is a relationship between recovery time and the economic losses associated with a natural catastrophe such as Hurricane Katrina Business interruption losses increase exponentially with response lag Fires burn uncontrolled Failed law enforcement, rioting and looting Delayed flood drainage Untimely mitigation of environmental release/contamination etc. Hurricane Katrina suggests a new externality for P/C insurers to consider: Mismanagement of the government s response and recovery efforts in the affected region(s)

12 Management in Light of Katrina Traditional approaches to risk assessment and CAT Modeling need to be revised to explicitly consider some of these new externalities (e.g., political uncertainty, etc.) into their overall analytical frameworks A clear need for increased geo-spatial sophistication and detail within CAT models, combined with the ability to perform cascaded inference (broken levee evacuation of affected area) Seriously rethink the implications of changes in risk appetite/tolerance and ambiguity aversion for risk management strategies and corporate decision-making Decision-Makers must become critical consumers of this technology not just passive receptors I.I.I.-Harvard Catastrophe Modeling Forum P/C Industry Resilience to Extreme Weather

13 25% 20% 15% 10% Cecelia Katrina/Rita/Wilma 5% 0% Frederic 9/11-5% Betsy Andrew Large loss hurricanes have been experienced in years, with both excellent and poor insurance industry returns Response of Return on Equity to One or More Quartet-Scale Losses Quartet-scale losses in 2007 cut insurers return on equity by 5.66%. However, more than half of the decline in profitability is eliminated by 2009 without any change in insurers operating procedures Long Run Return Two Quartets One Quartet Three Quartets

14 The impact of one Quartet-scale hurricane loss disappears after 6 years, with more than half the blow to profits wearing off after 2 years Two Quartet-scale losses in successive years result in greater losses, but the recovery period is only one year longer The insurance industry has displayed a powerful propensity to return to its long-term level of profitability after a series of large hurricane losses P/C Industry Resilience in Context The resilience of the industry's profitability in the face a series of Quartet scale storms is connected to the usual mechanisms of retrenchment by insurers in the shadow of large losses: higher premiums higher deductibles lower limits and reduced insurance availability in high risk areas Large storm losses will be followed by either: 1. A regime where prices are high enough to reflect the frequency and severity of losses in storm battered regions; or 2. A regime of controlled prices where insurance is scarce because government refuses to acknowledge the brute fact that insurers cannot provide protection for people and property in high risk places at low prices Industry resilience is necessarily accompanied by reductions in the quantity and affordability of insurance in the interest of financial viability

15 Protection in an Era of Climate Change The prospect of anthropogenic climate change has potentially far-reaching implications for the insurance and reinsurance industries Depending on how these risks are perceived by individual players within the industry, there exists a broad range of possible response options In the best of all possible worlds, insurers can opt to assume that the future will look much like the past In this business-as-usual scenario, insurers go about their business of managing risk in ways that are largely consistent with what they have traditionally done in the past Under this mindset, traditional paradigms and methods are deemed sufficient to adequately assess and manage these risks What if insured natural catastrophe losses continue to mount in ways that continue to surprise decision-makers and elude reliable forecasting? Faced with this situation, insurers may choose to direct more effort and resources at (i) better appraising these risks; and (ii) better managing their relevant exposure levels This course of action proceeds from the axiomatically accepted dictum within the industry that the risks in question can be reliably appraised using the language of probability and statistics The global climate system is fundamentally chaotic in nature, which may preclude the possibility of reliable short- to medium-term extreme weather forecasts, as well as the precise estimation of key weather-related factors (e.g., humidity, precipitation, atmospheric and seasurface temperature, and wind activity) INSURANCE INFORMATION INSTITUTE ON-LINE If you would like a copy of this presentation, please give me your business card with address Dr L James Valverde, Jr Vice President Economics and Risk Management Insurance Information Institute 110 William Street New York, NY Tel: (212) Fax: (212) jamesv@iii.org