III - Catastrophes: Insurance Issues

ISSUES UPDATES

Catastrophes: Insurance Issues

THE TOPIC

MAY 2009

The term “catastrophe” in the property insurance industry denotes a natural or man-made disaster that is unusually severe. An event is designated a catastrophe by the industry when claims are expected to reach a certain dollar threshold, currently set at $25 million, and more than a certain number of policyholders and insurance companies are affected.

Insured catastrophe losses for 2008 totaled an estimated $25.2 billion, according to ISO’s Property Claim Services Unit. While this does not come close to the $62.3 billion for 2005, the year of hurricanes Katrina and Rita, it is the fourth most costly in a decade. Insurers paid 3.9 million damage claims in 40 states as a result of 37 catastrophes, the highest number of catastrophic events in a single year since 1998. Personal lines claims accounted for 64 percent of the loss, commercial lines for 27 percent and vehicles for 9 percent. Texas suffered the largest loss at $10.2 billion. By contrast, losses for 2007, a year of little hurricane activity in the U.S., were $6.5 billion.

Meanwhile, the magnitude of the damage caused by Katrina and the potential damage hurricanes Rita and Wilma might have caused had they not weakened from intense Category 5 hurricanes has triggered a reexamination, not just among insurers and reinsurers but also among public policy and political leaders, of how the United States deals with the financial consequences of such massive property damage and personal loss.

Disaster losses along the coast are likely to escalate in the coming years, in part because of huge increases in development. One catastrophe modeling company predicts that catastrophe losses will double every decade or so due to growing residential and commercial density and more expensive buildings. Data from the Census Bureau, collected by USA Today, show that in 2006, 34.9 million people were seriously threatened by Atlantic hurricanes, compared with 10.2 million in 1950. Before the 2005 hurricane season, Hurricane Andrew ranked as the single most costly U.S. natural disaster.

Man-made catastrophes such as the attacks on the World Trade Center can also cause huge losses. The attacks led Congress to pass the Terrorism Risk Insurance Act (TRIA) in November 2002. Since then, TRIA has been reauthorized twice. The latest reauthorization, passed at the end of 2007, extends the law to 2014. TRIA provides a federal backstop for commercial insurance losses from terrorist acts, making it easier for insurers to calculate their maximum losses for such a catastrophe and thus to underwrite the coverage, see report on Terrorism Risk and Insurance.

The typical homeowners insurance policy covers damage from a fire, windstorms, hail, riots and explosions—as well as other types of loss such as theft and the cost of living elsewhere while the structure is being repaired or rebuilt after being damaged. Commercial property insurance policies generally cover the same causes of loss with some variation, depending on the coverages selected. Flood and earthquake damage are excluded under homeowners policies—separate policies are available—but are covered under the comprehensive portion of the standard auto policy, which more than 75 percent of drivers who buy auto liability insurance purchase.

Over the 20-year period 1988 to 2007, hurricanes and tropical storms made up 45.6 percent of total catastrophe losses, followed by tornado losses (26.5 percent), winter storms (7.9 percent), terrorism (7.4 percent), earthquakes and other geologic events (6.3 percent), wind/hail/flood (3.2 percent) and fire (2.6 percent). Civil disorders, water damage and utility services disruption combined represented less than 1 percent. Each year about 6 percent of homeowners file claims.

Related Information

RECENT DEVELOPMENTS

Catastrophes

Hurricanes: Forecasters at Colorado State University said in early April that they expected an average Atlantic basin tropical cyclone season in 2009, with 12 named storms rather than 14 as had been predicted in an earlier December 2008 forecast. The new forecast is based on expectations of a weak El Nino weather pattern in the mid to late hurricane season. Six of the storms are expected to become hurricanes, rather than seven, and two, rather than three, are likely to become at least Category 3 in intensity. There is a slightly greater than average chance that a major hurricane will make landfall this season. Other forecasters also expect an average year for hurricanes but some predict more activity on the East Coast this year than on the Gulf.
There were 16 named storms during the 2008 Atlantic hurricane season and nine hurricanes, making 2008 the year with the fourth-highest number of named storms. Combined, these 16 storms produced more than an estimated $11 billion in insured losses. Hurricane Ike was the most costly of the season, with an estimated $10.65 billion in insured losses, the fifth-most expensive (in 2008 dollars) among all hurricanes to hit the United States. By February 2009, the total claims count stood at nearly 730,000.
Tornadoes: The 2008 tornado season was one of the deadliest in a decade. The average annual number of tornado-related deaths for the 10 years, 1999-2008, is 63. One hundred and twenty-five people died in 2008. About 1,000 tornadoes occur each year, according to the National Oceanic and Atmospheric Administration, but this year 1,685 tornadoes were officially listed. Over the 20 years 1988 to 2007, tornadoes were responsible for 26.5 percent of all catastrophe losses, according to ISO. A report from Risk Management Solutions says that a season similar to 2008 could occur once every four to five years on average.
A study of tornado losses by A.M. Best, published in April 2008, notes that tornado losses of $1 billion and higher are becoming more frequent. Since 1953, tornadoes and associated weather events have caused almost 57 percent of all catastrophe losses on average, the report states. In 2007 they generated 69 percent—in part because the cost of damage from hurricanes in the U.S. that year was low.
Wildfires: In a forecast for the 2009 fire season, the National Interagency Fire Center identified four states with the greatest potential for wildfires: Arizona, New Mexico, California and north-central Washington, based drought conditions and the existence of dry undergrowth and other fire fuels.
Researchers are discovering that embers blown by the wind during wildfires cause most of the fires that burn homes. Also, homes that are less than 15 feet apart are more likely to burn in clusters. In such cases, fire is often spread by combustible fences and decks connected to houses, a study by the Institute for Business & Home Safety found. Thirty-eight states have wildfire risks, the Institute says, and the risk of wildfires keeps growing as more homes are built in wildland areas, some five million in California alone. Among the preventative features recommended in the study were noncombustible siding, decking and roofing materials; covered vents; and fences not connected directly to the house. In addition, combustible structures in the yard such as playground equipment should be at least 30 feet away from the house and vegetation 100 feet away.
In Santa Barbara County, California, a wildfire that began on May 5 had destroyed more than 75 homes as of May 13. In 2008, almost 5,000 wildfire claims were filed in California, according to the state’s insurance department.
Losses: According to initial estimates from Swiss Re, a large reinsurance company, more than 238,000 people died in natural and man-made disasters in 2008, the fourth highest number of deaths since 1970. The highest loss of life resulted from tropical cyclone Nargis, which struck Myanmar in early May, killing 138,400 people, and from a 7.9 magnitude earthquake that shook China’s Sichuan region. Some 87,000 people were killed and more than 10 million left homeless.
Coastal Area Growth: Data from the Census Bureau show that in 2008, 35.7 million people were seriously threatened by Atlantic hurricanes, compared with 34.9 million in 2006 and 10.2 million in 1950. Other Census data show that the coastal population in states stretching from North Carolina to Texas grew 251 percent between 1950 and 2008 and that the coastal population of Florida was 17.8 million in 2008, about 50 percent of the total coastal population in those states. Moreover, Florida’s coastal population grew one percent from 2007 to 2008, the Census Bureau estimates.
Property Insurance Availability and Affordability and Insurer Profitability: The availability of property insurance in coastal counties along the eastern seaboard from Florida to Cape Cod and the cost of that coverage have become grave concerns as insurers pull back from high-risk areas to reduce future potential hurricane losses and request to raise rates to levels commensurate with the risk they are assuming.
Some observers wonder why rates did not drop significantly when the industry was highly profitable in 2006 and 2007. Profits in an industry like insurance must be seen over the long term. In Florida a single hurricane or a string of large losses can wipe out profits from previous years or even decades. According to the Insurance Information Institute, from 1993 to 2003 the rate of return on net worth for all U.S. homeowners insurers was 2.8 percent, compared with 25 percent for Florida homeowners insurers. But when the years 2004 and 2005 are included, the picture is reversed. Over the period 1990-2006, the rate of return for U.S. homeowners insurers averaged -0.7 percent. For Florida insurers it averaged -38.1 percent, despite 2006 being a profitable year as a whole. Profits in other states cannot be used to subsidize rates in Florida or elsewhere and rates charged must be based exclusively on past trends and expected future losses in that state.

Proposals/Legislation Stemming from 2004/2005 Hurricanes
Adding Wind to Flood Coverage and Vice Versa: Among the many proposals put forward for dealing with property insurance issues are suggestions for reducing disputes over whether damage was caused by wind or flood. In 2007 legislation that reauthorized and reformed the National Flood Insurance Program included a provision that would have added optional wind coverage. The bill died, but the optional wind proposal was reintroduced in March 2009. The Obama Administration has indicated that it would not support such a provision. The flood program has a growing debt of more than $19 billion, it said, and because the federal insurance program must be actuarially sound, coverage provided by the federal government would not be less expensive than what is available in the private insurance market.
In a report released in May 2008 that underlined the difficulties in implementing such a program, the Government Accountability Office said that the homeowners most likely to purchase the optional wind coverage would be those with the highest likelihood of wind damage (a concept known as adverse selection in the insurance industry), making deficits likely; that a new distribution network would have to be created because insurers currently sell most flood insurance through the federal/private “Write-Your-Own” program (see report on Flood Insurance) and if wind was added they would not want to sell a coverage that competed with their own homeowners business, which includes coverage for wind; and that the flood insurance program is already burdened by $17 billion in debt as a result of the 2004/2005 hurricanes, making it difficult to take on a new and volatile wind program.
In a hearing on the bill, insurers stressed that most government-run property insurance programs aimed at providing coverage to high-risk policyholders, such as coastal property owners, operate at a deficit. Regulators are under political pressures to keep rates down in both the private market and state-operated pools, which, in turn, leads to larger pools as private insurers withdraw from high-risk areas and to higher deficits. If rates for wind coverage are commensurate with the risk and wind coverage is optional, as proposed, few homeowners will purchase it when they can obtain a much cheaper policy through the state. While many in the insurance industry oppose the wind/flood coverage proposal, several large homeowners insurers support the concept.
An associate professor at the Washington and Lee School of Law in Virginia, Adam Scales, has suggested that insurers sell a policy that covers both wind and flood. The federal government would reimburse insurers for the flood portion of claims. A similar proposal has been discussed by the National Association of Insurance Commissioners and one major homeowners insurer is considering such a concept. The company has not made a formal proposal to Congress but has discussed the plan with federal legislators, among others. The basic flood insurance portion of the policy would be sold at the same price as the federal program but policyholders would be able to buy additional coverage.
Creating a Federal Backstop: Proposals for a federal backstop generally envisage a three-layer plan: 1) policies sold by individual insurance companies; 2) state or regional catastrophe pools that provide reinsurance to insurers doing business in the state; and 3) a national megacatastrophe fund.
Four states at risk for megacatastrophes—Florida, Texas, Louisiana and California—are supporting federal legislation that would make it easier to sell bonds to finance the payment of claims in the event of a megacatastrophe. Under the bill (S 886), introduced by Sen. Bill Nelson, D-Fla., the Federal Reserve would guarantee the bond obligations of the states’ catastrophe funds, providing investors with a level of certainty that payments on the bonds would not cease in the event the state defaulted on the bond. The bill also covers bonds issued by Florida’s Citizens Insurance Corporation. The money borrowed through issuing bonds would be repaid by assessments on insurers and policyholders.
In February 2009 Nelson reintroduced the Homeowners Defense Act, which would establish a National Catastrophe Risk Consortium. The bill, introduced last year in both houses of Congress, would ensure that state entities have the funds after a disaster to make good on their financial commitments to property owners. To accomplish this, the consortium would provide technical assistance and facilitate the transfer of risk to private markets, through for example, catastrophe bonds, see report on reinsurance. Loan commitments from the U.S. Treasury would provide liquidity and long-term financing to the state entities participating in the program. Before becoming President, Obama said that he would support such a program. In Florida, Texas and Louisiana the pools that were supposed to be a market of last resort are now are major providers of property insurance and are in danger of running out of money in part because rates have been suppressed for so long.
A suggestion that relies on the federal government to set risk-based rules and underwriting guidelines for a specially designated “wind zone” has been put forward by two leading property insurers and insurance agent and brokerage organizations. The plan would provide a comprehensive, private market approach to improve the affordability and availability of windstorm insurance for homeowners in coastal areas, supporters say. The proposal is based on four concepts: a uniform set of rules applied to wind coverage for wind zones from Texas to Maine; risk-based, actuarially sound rates using approved standards and wind risk models; federal reinsurance sold at cost for extreme events such as a hurricanes that caused losses in excess of $100 billion; and incentives for state and local governments to adopt federal guidelines for appropriate building codes and land use planning.
Some insurance groups are in favor of a federal role while others are not. Some say that under the current system the federal government (and hence taxpayers) pay for rebuilding in any case through government grants and low interest loans and that the funds would be better spent in an organized and predictable fashion. Other insurers say that worldwide there is enough reinsurance capacity to protect U.S. primary insurers against catastrophe losses and that people who choose to live in disaster-prone areas should not be protected from the cost of their decisions through subsidies from people who choose to live in a less risky location. They believe the solution is for Congress and state legislatures to develop more stringent building codes and tax incentives for homeowners to prepare for hurricanes.
State Responses: A New York State regulation will require each property insurer to create a contingency catastrophe reserve fund, setting aside 5 percent of its homeowners insurance premium in the first year. The rule applies to financial statements filed on or after July 2009.
Currently, policyholders pay for catastrophe coverage as part of their property insurance premiums. The “catastrophe load” varies with the insurer and the geographic location of the property. Upstate residents generally pay less for such coverage while Long Islanders, who are exposed to hurricanes, generally pay more.
Major disasters occur infrequently. Since insurers currently cannot set up reserves for events that have not happened, when there is no catastrophe, the catastrophe portion of the premiums is rolled over into underwriting profits and, in a stock company, may be distributed to shareholders. Under the new regulation, insurers will retain this portion in a separate fund for the payment of future catastrophe claims. This will reduce the risk of insolvencies in the event of a massive disaster, the New York insurance department says, and also increase transparency for consumers. Consumers will be able find out how much money is set aside for disaster claims and if the catastrophe reserves prove insufficient, they will understand the need for higher insurance prices.
Under the new New York regulation, funds may be drawn down only when there is a major disaster that meets the definitions of a catastrophe set out by the Property Claims Service, a unit of ISO. PCS surveys the industry after a disaster to find out the likely cost of claims, the number of claims expected and the number of insurers affected by the event. The department estimates that aggregate monies set aside by each company will together amount to $196 million in the first year. After 30 years, the first annual contribution including investment income, to the extent it has not been used to pay catastrophe claims, will be considered income and removed from the reserve fund.
New York Insurance Superintendent, Eric Dinallo, says the insurance department supports a nationwide mandate to require insurers to create catastrophe reserve funds and would like to see favorable tax treatment for such reserve funds, but this would require federal legislation. In recognition that the reserve is considered income for accounting purposes and is therefore subject to taxation, the department says it revised its proposal and now requires the reserve to be established net of any federal or state taxes incurred.
In Florida lawmakers passed a bill (HR 1495) that will, among other things, allow Citizens rates to increase annually at 10 percent per policyholder until it is actuarially sound and will gradually phase out a portion of the upper levels of the Hurricane Catastrophe Fund at $2 billion per year over six years to reduce the state’s exposure to loss. The increases start in January 2010. (A provision to apply 10 percent of the newly generated revenue for Citizens to My Safe Florida Home mitigation grants to strengthen homes against wind damage was not approved.) Insurers will be able to file for rate increases of up to 10 percent on an expedited basis to recoup the increased costs of replacing the Catastrophe Fund reinsurance with coverage purchased from private insurers.
Initially, after Hurricane Katrina and other damaging storms, the state of Florida seemed to ignore the risk of severe hurricane damage. It responded to the potential for increased hurricane losses by assuming greater financial risk in the event that the state were hit by a major storm. Citizens was underfunded—its rates were frozen until the end of 2009. In addition, lawmakers failed to reduce the amount of reinsurance available under the Hurricane Catastrophe Fund, see below, as suggested by some state officials who were concerned about its claims paying ability in the likely event that the state cannot sell enough bonds to raise money.
In South Carolina, homeowners who make their homes more resistant to hurricane damage can now get sales and income tax reductions and discounts on homeowners insurance. Legislation passed in June 2007 also allows them to set up tax-deductible hurricane savings accounts to fund large deductibles in the event of damage or to use the savings to pay construction costs themselves if they go without insurance altogether. Under the same bill, insurance companies are given premium tax credits for writing full coverage homeowners insurance in wind pool areas. In addition, the wind pool’s boundaries were expanded to cover more communities and its policyholders are required to purchase flood insurance.
Maryland requires insurance companies to obtain prior approval for withdrawal from coastal areas and for hurricane deductibles above 5 percent of the policy limit. It also requires insurers to offer discounts to property owners who take steps to reduce catastrophe losses.
In Louisiana, legislation providing financial incentives to insurers that agreed to assume policies from the state’s insurer of last resort was passed in 2007. The goal was to make homeowners insurance more affordable and reduce the size of the Louisiana Citizens Property Insurance Corporation. Many of the insurers that have applied are new companies; some were initially set up in Florida to assume policies from that state’s insurer of last resort. In addition, Louisiana allows insurers that write new business in the state to apply to the insurance department for permission to adopt new hurricane deductibles based on the property’s distance from the Gulf of Mexico.
After Hurricane Katrina, many states vowed to consider state catastrophe funds. More recently, in most states where state catastrophe funds have been proposed the idea has been rejected by lawmakers. Many question whether such programs could succeed without federal backing. Recently, the National Conference of Insurance Legislators rejected a resolution to support the creation of state-based catastrophe funds.
Reducing Catastrophe Losses: An indication of the potential savings from upgrading building codes and stringent enforcement of existing codes comes from the National Institute of Building Sciences, which estimates that society saves an average of $3.65 for every federal dollar spent on mitigation.
In Florida, the insurance department has adopted the Home Structure Rating System, a scale from 1 to 100 that scores homes based on their ability to withstand damage from high winds. The system implements a bill enacted in 2006. Homeowners who make their homes more resistant to damage from hurricane force winds are now seeing a larger discount on the wind coverage portion of their homeowners insurance premium, depending on the extent to which mitigation features such as hurricane shutters, roof coverings and shape, and the way the roof is attached reduce potential wind damage. In Broward County, for example, the program has saved participants an average of $385, or 20 percent, according to the Florida Department of Financial Services. A state home inspection program offered at no charge through My Safe Florida Home has shown thousands of homeowners how to reduce their home's vulnerability to storm damage. Some received grants for retrofitting.
Many states have passed legislation requiring insurers to offer discounts for strengthening their homes, including Louisiana and South Carolina and others have upgraded their building codes. In Mississippi, a state that lacked a statewide building code, the Governor approved HB 1465 in March 2008. The measure requires that all new buildings in cities and counties with building codes be based on current standards and provides funding for training officials to enforce the code and for a study of the cost/benefits of construction features that can strengthen commercial buildings and homes. The insurance industry was part of the Coalition to Build a Stronger Mississippi, which was instrumental in getting the law passed. The state is also providing funds to allow eligible homeowners to receive financial assistance to build or upgrade homes to stronger construction standards. A study California recently strengthened its building code, incorporating international building and fire standards and state-specific codes for earthquake and wildfire-prone zones.
The Institute for Business & Home Safety (IBHS) is creating a research center to test building and construction components for durability when exposed to high winds, wind-driven water, earthquakes and hail as well as maintenance-related concerns like plumbing system failure and interior fires. The results will be used in consumer education and advocacy campaigns.
Increasingly, consumers are embracing the idea of living in homes that can better withstand severe windstorms and other disasters. More than 200 “Fortified… for Safer Living” projects, which incorporate specific safety design features supported by IBHS, have been completed or are in various stages of construction in 16 different states, IBHS says, including states in the Midwest. IBHS says that Fortified requirements strengthen a home’s outer envelope, notably the roof and wall systems, doors, windows and other glazed openings, and the foundation.
Builders of various types of disaster-resistant structures are finding that the public’s appetite for stronger homes has been stimulated by Hurricane Katrina, forecasts of continuing hurricane activity and the inevitability of a severe earthquake in the West at some point in the future. In Mississippi the wind pool has agreed to give owners of homes built to a Fortified standard a 25 percent credit toward the windstorm part of property insurance policies initially, and a lesser amount over the next four years, according to the IBHS. In Alabama, the Beach Pool is offering discounts for homes built to fortified standards.
Validating the concept of “Fortified” homes, all but three of the 17 homes built to the original criteria on the Bolivia Peninsula in Gilchrist, Texas survived Hurricane Ike’s high winds. The three that were damaged were knocked off their foundations by flying debris from non-Fortified homes, which were reduced to slabs.
Residual Markets: Growth of state-run property insurers is shifting the financial burden of potential hurricane-related damage to all policyholders and taxpayers in these states as they devise ways to fund the claims they will have to pay. By year-end 2007, these insurers had a $670 billion exposure to loss, compared with $54.7 billion in 1990.
In Texas, the Texas Windstorm Insurance Association (TWIA) is running out of money. Legislation proposed to put the pool in a stronger financial position is being held up by the inability of lawmakers representing coastal interests to find common ground with those representing inland counties. The pool, which has more than 229,000 policyholders, handled almost 100,000 claims as a result of damage caused by Hurricane Ike. Insurance companies were assessed $430 million, of which $230 million will be offset or recoupable through credits on the premium tax, the state tax that all insurers are assessed in every state based on their premiums written in that state. Funds were also transferred to the TWIA from the Catastrophe Reserve Trust Fund ($370 million). Together, these funds allowed TWIA to reach the threshold or provide the retention needed to access its reinsurance. All of these funds total $2.1 billion. This assessment follows an earlier one after Hurricane Dolly. Insurers will be assessed again to cover any additional losses above $2.1 billion. See the report on Residual markets for more information.
In Mississippi, under legislation passed in March 2007, additional funds will be transferred to the Mississippi Windstorm Underwriting Association, along with a portion of the revenue received from state insurance premium taxes for a four-year period, so that it can build up reserves. In addition, the pool will be able to surcharge policyholders directly if it has to issue bonds or repay loans and insurers will be able to pass on to policyholders their share of assessments for deficits.
In South Carolina, the wind pool was expanded in 2007 to additional counties, reducing the number of policies cancelled by private insurers who can now issue a property policy without wind coverage since this can be purchased separately from the pool.
Florida Hurricane Catastrophe Fund: At the end of the legislative session, lawmakers passed a bill (HR 1495), which will gradually phase out a portion of the upper levels of the Hurricane Catastrophe Fund at $2 billion per year over six years to reduce the state’s exposure to loss and will increase premiums for reinsurance from the fund by 5 percent a year until 2013 and by 25 percent for every following year. Certain insurers that have not filed for a rate increase within the previous six months and do not file for one within the next six months will be able to file for rate increases of up to 10 percent on an expedited basis to recoup the increased costs of replacing the fund reinsurance with coverage purchased from private insurers.
The Fund is in poor financial condition. Many insurance companies purchase reinsurance from the fund but it could find itself short of money in the event of a devastating storm because of the current credit crisis and the effect that has had on the municipal bond market. In a worst case scenario, the fund could be required to pay out $27.8 billion in losses but it can raise only a portion of that in today’s municipal bond environment. But the likelihood of having to pay out $27.8 billion in the near future is remote, according to fund officials, who are hoping to find solutions to the problem before the 2009 hurricane season begins in June.

THE TEN MOST COSTLY CATASTROPHES, UNITED STATES (1)

			Insured loss ($ millions)
Rank	Date	Peril	Dollars when occurred	In 2008 dollars (2)
1	Aug. 2005	Hurricane Katrina	$41,100	$45,309
2	Aug. 1992	Hurricane Andrew	15,500	23,786
3	Sep. 2001	World Trade Center, Pentagon terrorist attacks	18,779	22,830
4	Jan. 1994	Northridge, CA earthquake	12,500	18,160
5	Oct. 2005	Hurricane Wilma	10,300	11,355
6	Sep. 2008	Hurricane Ike	10,655 (3)	10,655 (3)
7	Aug. 2004	Hurricane Charley	7,475	8,520
8	Sep. 2004	Hurricane Ivan	7,110	8,104
9	Sep. 1989	Hurricane Hugo	4,195	7,284
10	Sep. 2005	Hurricane Rita	5,627	6,203
(1) Property coverage only. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2008 dollars by the Insurance Information Institute. (3) Estimated. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

INSURED LOSSES, U.S. CATASTROPHES, 1999-2008 (1)

Year	Number of catastrophes	Number of claims (millions)	Dollars when occurred ($ billions)	In 2008 dollars (2) ($ billions)
1999	27	3.2	$8.3	$10.7
2000	24	1.5	4.6	5.8
2001	20	1.5	26.5	32.2
2002	25	1.8	5.9	7.1
2003	21	2.7	12.9	15.1
2004	22	3.4	27.5	31.3
2005	24	4.4	62.3	68.7
2006	33	2.3	9.2	9.8
2007	23	1.2	6.7	7.0
2008	37	3.9	25.2	25.2
(1) Includes catastrophes causing insured losses to the industry of at least $25 million and affecting a significant number of policyholders and insurers. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2008 dollars by the Insurance Information Institute. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

MAJOR U.S. CATASTROPHES, 2008

As of January 20, 2009 ($ millions)

Date	Catastrophes	States	Estimated insured loss (1)
First quarter
Jan. 4-9	Wind, hail, tornadoes, flooding, freezing, ice, snow	AR, CA, IL, IN, KS, MI, MO, NY, OH, OK, OR, WA, WI (2)	$745

Feb. 5-6	Wind, hail, tornadoes	AL, AR, IN, KY, MS, OH, TN, TX (2)	955

Mar. 15-16	Wind, hail, tornadoes	GA, SC	560

Total first quarter losses			3,545 (3)

Second quarter
May 22-26	Tornadoes, storms	CO, IA, KS, MN, NE, OK, WY	1,325

Total second quarter losses			7,110 (4)

Third quarter
Jul. 23	Hurricane Dolly	TX	525
Aug. 18-25	Tropical Storm Fay	AL, FL, GA	245
Sep. 1	Hurricane Gustav	LA	2,100
Sep. 6	Tropical Storm Hanna	NC, VA	80

Sep. 12-14	Hurricane Ike	AR, IL, IN, KY, LA, MO, OH, PA, TX	10,655

Total third quarter losses			14,270 (5)

Fourth quarter
Dec. 11-13	Flooding, ice, snow, wind	MA, ME, NH, NY, UT	275

Total fourth quarter losses			275 (6)

Total losses (full year)			$25,200
(1) Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Possibly other areas. (3) Includes nine events. (4) Includes 16 events. (5) Includes 11 events. (6) Includes one event. Note: Catastrophes are assigned serial numbers by the Property Claim Services (PCS) Unit of ISO when the insured loss to the industry resulting from an occurrence reaches at least $25 million and affects a significant number of policyholders and insurers. Source: ISO's Property Claim Services Unit.

MAJOR U.S. CATASTROPHES, 2007

As of April 2008 ($ millions)

Date	Catastrophes	States	Estimated insured loss (1)
First quarter
Mar. 1-2	Tornadoes	AL, GA	$500

Total first quarter losses			1,255 (2)

Second quarter
Apr. 13-17	Flooding, hail, tornadoes, wind	CT, DE, DC, GA, LA, ME, MD, MA, MS, NH, NJ, NY, NC, PA, RI, SC, TX, VT, VA	1,350
May 2-3	Flooding, hail, tornadoes, wind	TX	100
May 4-8	Flooding, hail, tornadoes, wind	IA, SD, MO, KS, MN	260

Total second quarter losses			2,300 (3)

Total third quarter losses			1,250 (4)

Oct. 21-24	Witch wildland fire	CA	1,300

Total fourth quarter losses			1,905 (5)

Total losses (full year)			$6,710
(1) Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Includes seven events. (3) Includes six events. (4) Includes six events. (5) Includes four events. Note: Catastrophes are assigned serial numbers by the Property Claim Services (PCS) Unit of ISO when the insured loss to the industry resulting from an occurrence reaches at least $25 million and affects a significant number of policyholders and insurers. Source: ISO's Property Claim Services Unit.

TOP 15 MOST COSTLY HURRICANES IN THE UNITED STATES

($ millions)

				Estimated insured loss (1)
Rank	Date	Location	Hurricane	Dollars when occurred	In 2008 dollars (2)
1	Aug. 25-30, 2005	AL, FL, GA, LA, MS, TN	Katrina	$41,100	$45,309
2	Aug. 24-26, 1992	FL, LA	Andrew	15,500	23,786
3	Oct. 24, 2005	FL	Wilma	10,300	11,355
4	Sep. 12-14, 2008	AR, IL, IN, KY, LA, MO, OH, PA, TX	Ike	10,655 (3)	10,655 (3)
5	Aug. 13-14, 2004	FL, NC, SC	Charley	7,475	8,520
6	Sep. 15-21, 2004	AL, DE, FL, GA, LA, MD, MS, NJ, NY, NC, OH, PA, TN, VA, WV	Ivan	7,110	8,104
7	Sep. 17-22, 1989	GA, NC, PR, SC, VA, U.S. Virgin Islands	Hugo	4,195	7,284
8	Sep. 20-26, 2005	AL, AR, FL, LA, MS, TN, TX	Rita	5,627	6,203
9	Sep. 3-9, 2004	FL, GA, NC, NY, SC	Frances	4,595	5,237
10	Sep. 15-29, 2004	DE, FL, GA, MD, NJ, NY, NC, PA, PR, SC, VA	Jeanne	3,655	4,166
11	Sept. 21-28, 1998	AL, FL, LA, MS, PR, U.S. Virgin Islands	Georges	2,955	3,903
12	Oct. 4, 1995	FL, AL, GA, NC, SC, TN	Opal	2,100	2,967
13	Sep. 14-17, 1999	NC, NJ, VA, FL, SC, PA, 10 other states	Floyd	1,960	2,533
14	Sep. 11, 1992	Kaui and Oahu, HI	Iniki	1,600	2,455
15	Sep. 5, 1996	NC, SC, VA, MD, WV, PA, OH	Fran	1,600	2,196
(1) Property coverage only. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2008 dollars by the Insurance Information Institute. (3) Estimated. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

THE TEN MOST COSTLY WILDLAND FIRES IN THE UNITED STATES (1)

($ millions)

			Estimated insured loss
Rank	Date	Location	Dollars when occurred	In 2008 dollars (2)
1	Oct. 20-21, 1991	Oakland Fire, CA	$1,700	$2,687
2	Oct. 21-24, 2007	Witch Fire, CA	1,300	1,350
3	Oct. 25-Nov. 4, 2003	Cedar Fire, CA	1,060	1,240
4	Oct. 25-Nov. 3, 2003	Old Fire, CA	975	1,141
5	Nov. 2-3, 1993	Los Angeles County Fire, CA	375	559
6	Oct. 27-28, 1993	Orange County Fire, CA	350	521
7	Jun. 27-Jul. 2, 1990	Santa Barbara Fire, CA	265	437
8	May 10-16, 2000	Cerro Grande Fire, NM	140	175
9	Jun. 23-28, 2002	Rodeo Chediski Complex Fire, AZ	120	144
10	Sep. 22-30, 1970	Oakland & Beverly Hills Fire, CA	25	138
(1) Property coverage only for catastrophic fires. Effective January 1, 1997, Property Claim Services (PCS) Unit defines catastrophes as events that cause more than $25 million in insured property damage and that affect a significant number of insureds and insurers. From 1982 to 1996, PCS used a $5 million threshold in defining catastrophes. Before 1982, PCS used a $1 million threshold. (2) Adjusted to 2008 dollars by the Insurance Information Institute. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

TOP TEN STATES FOR WILDLAND FIRES RANKED BY NUMBER OF FIRES, 2008

Rank	State	Number of fires	Number of acres burned
1	Texas	16,713	1,570,586
2	California	5,812	1,339,839
3	Oklahoma	5,572	196,563
4	Georgia	5,454	23,081
5	North Carolina	4,414	95,938
6	Alabama	3,103	32,447
7	Florida	2,939	156,102
8	South Carolina	2,626	15,751
9	Mississippi	1,898	27,399
10	Arizona	1,850	85,496
Source: National Interagency Coordination Center.

BACKGROUND

The insurance industry tracks catastrophes to monitor claim costs, assigning a number to each catastrophe. Each claim arising from the event is tagged so that total industrywide losses can be tabulated. The term catastrophe is often used in the property insurance industry in a narrow way to mean a catastrophic event that exceeds a dollar threshold in claims payouts. This figure has changed over the years with inflation and the increase in development of areas subject to natural disasters. Starting in 1997 the catastrophe definition was raised from $5 million to $25 million in insured damage. As a result, the number of recorded catastrophes and the aggregate losses attributed to catastrophes has been on average lower since 1997 than in earlier years.

While $25 million is a large figure to most people, there have been four catastrophes that fall into the megacatastrophe category, greatly exceeding that amount. The first two, Hurricane Andrew (1992) and the Northridge earthquake (1994), were both watershed events in that they were far more destructive than most experts had predicted a disaster of this type would be. The third, the terrorist attack on the World Trade Center in 2001, altered insurers’ attitudes about man-made risks worldwide. Hurricane Katrina (2005), the fourth catastrophe, is not only the most expensive natural disaster on record but also an event that intensified discussion nationwide about the way disasters, natural and man-made, are managed. It also focused attention on the federal flood insurance program, see report on Flood Insurance.

Hurricane Andrew: Hurricane Andrew, which hit the Bahamas and Southern Florida August 23-24, 1992, and then moved across the Gulf of Mexico to strike portions of Louisiana and other southeastern states on August 25-26, was the costliest natural disaster in U.S. history before Hurricane Katrina. With peak wind gusts of almost 200 mph, the hurricane flattened whole communities, leaving in its wake a wasteland of debris. Eleven property/casualty insurers became insolvent due to Hurricane Andrew (10 in Florida and one in Louisiana) and others were financially impaired. Some of the state’s largest homeowners insurance companies had to be rescued by their parent companies and others had to dig deep into their surplus to pay Hurricane Andrew claims. Allstate, for example, paid out $1.9 billion, $500 million more than it had made in profits from its Florida operations from all types of insurance and investment income on those funds over the 53 years it had been in business. In total there were 680,239 claims, including 161,400 for damage to automobiles.

The Northridge Earthquake: The Northridge earthquake measured 6.8 on the Richter scale. It jolted the San Fernando Valley, 20 miles northwest of downtown Los Angeles, on January 17, 1994, causing more than 60 deaths and 12,000 injuries and destroying some 8,000 homes. More than 114,000 buildings were damaged and some 430,000 claims were filed. In both natural disasters, Hurricane Andrew and the Northridge earthquake, homeowners accounted for the bulk of claims and claim dollars.

The Destruction of the World Trade Center: The World Trade Center disaster impacted many kinds of insurance companies, particularly commercial lines companies. Claims were also filed with life insurance companies as well as personal lines insurers. The number of people known to have died as a result of the attacks on the World Trade Center complex has been officially set at 2,976. More than 35,000 claims were filed in New York State alone, according to the New York Department of Insurance. Broken down by type, two-thirds were commercial claims and one third personal, mostly property claims. Lost income and extra expense claims for the cost of getting the business back on track, part of property insurance, represented more than one quarter of the dollars paid out. More than 5,600 workers compensation claims were filed. Other claims were paid by insurance companies to businesses that suffered indirect losses in other parts of the country. These were not reported to the New York Insurance Department.

Other large U.S. man-made disaster losses in the last two decades include those stemming from the Los Angeles riots in 1992, at $775 million, and the World Trade Center bombing in 1993, at $510 million, see charts above.

Hurricane Katrina: Katrina, the storm that most affected attitudes about managing natural disaster risk, made landfall first in Florida on August 25, 2005 as a Category 1 storm, then gathered strength as it crossed the warm waters of the Gulf of Mexico, ultimately hitting Louisiana on August 29 as a strong Category 3 storm. The hurricane generated more than 1.7 million claims, more than half of the total in Louisiana. The bulk of the claims, 1.2 million, were for personal property. There were 346,000 claims for damaged vehicles and some 156,000 commercial claims. Claims payments to businesses accounted for half of the $40.6 billion bill for insured losses.

Katrina left more devastation and a higher reconstruction bill in its wake than any previous storm, in part because of extensive commercial and residential development along the Gulf Coast; the record breaking storm surge, reported to be as high as 29 feet in some areas; and the concentration of energy related and other high value businesses in its path. Katrina’s hurricane force winds at landfall covered a wide area, extending for 250 miles, twice as far as Hurricane Andrew. Because the damage was so severe and widespread, the demand for materials and skilled labor quickly exceeded the readily available supply, pushing up construction prices and hence the cost of property insurance claims.

The 2005 hurricane season exposed many weaknesses in the nation’s preparedness for megadisasters. For example, many people in flood zones had failed to buy flood insurance, see report on flood insurance, and many communities in harm’s way did not have or had not enforced strong building codes, which would have reduced the amount of wind damage. In addition, the disasters drew attention to the need to reconsider land use patterns in areas most vulnerable to storm damage.

Hurricanes: A hurricane's winds revolve around a center of low pressure expressed in millibars, or inches of mercury, and the entire system moves slowly. Hurricanes are categorized on the Saffir/Simpson intensity scale, which ranges from 1 to 5, reflecting a hurricane's wind and ocean-surge intensity. Below is the Saffir/Simpson Classification System.

THE SAFFIR/SIMPSON CLASSIFICATION SYSTEM FOR HURRICANES

Category	Wind Speeds	Pressures	Storm Surge	Damage
1	74-95 mph	Greater than 980 mb	4-5 ft.	Light
2	96-110 mph	965-979 mb	6-8 ft.	Moderate
3	111-130 mph	945-964 mb	9-12 ft.	Extensive
4	131-155 mph	920-944 mb	13-18 ft.	Extreme
5	More than 155 mph	Less than 920 mb	Greater than 18 ft.	Catastrophic

A windstorm becomes a tropical storm when average wind speeds reach 39 mph. The hurricane season runs from June 1 to November 30, but the height of the season is from mid-August to mid-October.

The number and severity of hurricanes seems to run in cycles. Experts now think these cycles are influenced by several factors: the amount of rainfall in the Sahel region of West Africa just below the Sahara Desert and the pressure and temperature conditions there, the direction of equatorial stratosphere winds, Atlantic Ocean and Caribbean Sea level pressure readings and the oceanic warm-water pattern known as El Nino. Between 1947 and 1969, a rainy period in the Sahel, 17 major hurricanes (Category 3 or greater) struck the East Coast of the United States, compared with 10 between 1970 and 1991, when the Sahel was experiencing a drought. Climatologists believe changing climatic conditions in the tropics signal a period of more intense hurricane activity.

New research suggests that the degree of hurricane activity in the Atlantic Basin is not a proxy for the number of storms that are going to make landfall along the U.S. coastline. According to researchers at AIR Worldwide, the probability of landfall is linked most closely to a storm’s genesis, or where it forms, rather than the number of tropical storms in the Atlantic. Genesis patterns change from year to year. The key to understanding why in some years the number of storms making landfall in the United States is high and in others it is low is to compare long-term genesis and storm tracking patterns, the AIR study notes.

Many of the most severe hurricanes have originated near the Cape Verde Islands off the West Coast of Africa. Recently, hurricane experts have been studying what has become known as the "Atlantic Conveyor Belt," a stream of warm water that moves north up the East Coast from Florida and loops around to Greenland, where it cools and turns south again. The belt of water flows at different speeds in 20 to 30 year cycles. For the past 25 years, it has flowed slowly but is now accelerating, creating conditions favorable to hurricanes. Some scientists attribute the increased hurricane activity to global warming, but others say there no evidence to support this. There is some indication that higher water temperatures over the Gulf of Mexico are contributing to the overall greater intensity of the storms.

Florida is the state most vulnerable to hurricanes. Reliable records on hurricanes only go back to the 1870s. Sketchy accounts of earlier disasters exist in ship’s logs and journals. Now, geologists, supported in part by insurers, hope to add to the written record by examining sediments at the bottom of coastal lakes and marshes. During a hurricane, sand and shell debris get swept into these waters. Research so far suggests that between 1,000 and 2,000 years ago, there were five or six Category 4 and 5 hurricanes in the Florida panhandle.

Data compiled by the National Oceanic and Atmospheric Administration (NOAA) on the 30 most powerful storms over the period 1900 to 1996 show that more than 40 percent of the damage they caused occurred in southeast Florida. Of the 158 hurricanes that hit the United States, 47 hit Florida and 26 of those struck the Southeast Florida coast.

Recently, computer simulation models have been developed that can mesh long-term disaster information with current demographic data to produce potential claims losses for any given geographical location under various scenarios. This information allows insurers to better differentiate between high- and low-risk areas in states such as Florida, where formerly, in times of less sophisticated risk delineation, the entire state may have been considered high risk. In addition, computer programs designed to help underwriters evaluate a building's potential damage from windstorms allow insurers to price industrial property insurance coverages more accurately. The ability to generate such information has also led insurers to reassess their business strategies.

But quality and type of building construction are not the only factors that influence the extent of damage a windstorm can cause. Others include the number and type of trees in an area and the type of soil, both of which affect the potential for losses due to falling trees. Soft woods, such as pine, tend to have shallow roots so that they are more easily uprooted than hard woods like oak, particularly in places with sandy soil. Storm surges will cause more damage where the developed land is close to sea level rather than elevated.

Coastal Development: A study published in 2004 by NOAA, based on U.S. Census data, found that in 2003, 53 percent of the nation’s population—153 million people—lived in coastal counties (including those that abut the Great Lakes), which in total make up 17 percent of the country’s land mass. For the purposes of the study, a coastal county must be part of a coastal watershed but it does not have to have a shoreline. These ratios have remained steady since 1970 but the number of people has steadily increased. Twenty-three of the 25 most densely populated areas are coastal. Put another way, in 1960 an average of 187 people were living on each square mile of the U.S. coast, excluding Alaska. In 1994, that figure was 274 per square mile, and it is expected to reach 327 people by 2015. The West Coast is in the highest earthquake risk zone.

Between 1980 and 2003, the population of coastal counties grew by 33 million people, or 28 percent. Florida grew 75 percent, Texas 52 percent and Virginia 48 percent. More growth is expected with the highest growth expected in the southernmost part of Florida, the region most exposed to hurricanes. Coastal counties in the Carolinas and Georgia are also expected to see considerable population increases. Large increases are forecast for the Houston, Texas area and Florida’s central Gulf Coast. According to population growth projections by the U.S. Census Bureau, by 2030 more than 12 million additional people will be living in Florida and Texas.

Exposure to windstorms and high property values combine to make Florida the state with the highest potential for losses and New York's Long Island the second highest. A 2007 study by AIR Worldwide put the value of insured coastal property in hurricane-prone states—states bordering on the Atlantic Ocean and Gulf of Mexico—at $8.89 trillion. The value of residential and commercial coastal property in Florida alone was almost $2.46 trillion. This represented 79 percent of the state’s total insured property values. In New York it was $2.38 trillion, representing 62 percent of the total. Other states where insured coastal property values exceeded 50 percent of the state’s total are Connecticut, Maine and Massachusetts.

The growth and concentration of property values in hurricane-prone areas has pushed to the forefront of public policy debates the issue of coastal development and hidden insurance subsidies. Subsidies exist in various aspects of the property insurance transaction. First, they exist where rates for property insurance are no longer commensurate with risk because it is politically unpalatable to raise rates to actuarially justified levels. Second, there are subsidies in the pooling arrangements that were set up to make sure people living along the coast can obtain property insurance. When these pools have insufficient funds to pay claims, the shortfall is picked up by insurance companies, which may then pass the cost on to all property insurance policyholders in the state through explicit policy surcharges, as in Florida, or indirectly in the form of higher property insurance rates.

Catastrophe Deductibles: After Hurricane Andrew, with computer-based models of storms, coastal development patterns and increasing values all indicating how vulnerable insurers were to large weather-related losses, homeowners insurers had difficulty finding the reinsurance coverage they needed to protect their own bottom line. Many homeowners insurers couldn't obtain reinsurance coverage unless they agreed to greatly reduce their potential maximum losses from such events through higher deductibles. These deductibles exist in regions prone to hail as well as hurricane damage. They are generally equal to a percentage of the structure's insured value as opposed to a straight dollar amount, such as $1,000. Eighteen states and the District of Columbia have what have become known as hurricane deductibles.

Percentage deductibles for windstorm losses, which may be mandatory in some coastal areas of a state, vary from 1 percent of the home's insured value to 15 percent, depending on many factors that differ from state to state, and sometimes from insurer to insurer, including the home's insured value and the "trigger," the nature of the event to which the deductible applies. In some states or portions of a state, policyholders have a "buy back" option — paying a higher premium in return for a traditional dollar rather than percentage deductible. The percentage deductibles may apply to the entire state or just part of it (see Hurricane and Windstorm Deductibles paper).

For hail damage, in addition to instituting percentage of limits deductibles, some insurers in some states are providing coverage for roofs on a depreciated (actual cash value) basis, rather than replacing a damaged roof with a new one. Some insurers are offering a discount for hail- resistant roofs or imposing a surcharge for roofs that are not hail resistant to encourage people to replace old roofs with new, less damageable ones.

Earthquakes: On the West Coast, earthquakes represent the greatest threat. Statistics show that since 1900, earthquakes have occurred in 39 states and have caused damage in all 50. About 5,000 quakes can be felt each year, with some 400 capable of causing damage to the interior of buildings and 20 capable of causing structural damage. A major earthquake (8.2 on the Richter scale) in San Francisco today could cause as much as $100 billion in insured damage. However, a major earthquake on the East Coast, though more unlikely, could cause much greater damage. Because earthquakes in the eastern part of the country tend to be thrust-fault quakes, which produce an up-and-down motion rather than the horizontal side-to-side common in California, damage could be 10 times greater, according to seismic experts. The degree of damage also depends on other variables such as the structure of the building and soil conditions (see Earthquakes: Risk and Insurance Issues paper).

A study by Dr. Haresh Shah of Risk Management Solutions and Stanford University, which draws on data from the 1994 Northridge quake and the 1995 quake in Kobe, Japan, suggests the ground shaking at a quake's epicenter can be more violent than expected. This finding has pushed up earlier estimates for loss of life and property damage in the event of a megaquake. An 8.3 magnitude quake in San Francisco, the same in intensity as the quake in 1906, could cause up to 8,000 deaths and between $80 and $105 billion in insured losses, with total losses as high as $225 billion. (Total damage from the Kobe, Japan, quake was $147 billion, of which only $4.1 billion was insured.) New estimates of the potential damage to Tokyo in a major earthquake are numbing. A quake similar to the one that destroyed the city in 1923 could cause as much as $4.3 trillion in total losses.

California insurers collected only $3.4 billion in earthquake premiums in the 25-year period prior to the Northridge earthquake and paid out more than $15.3 billion on Northridge claims alone. After the Northridge earthquake, insurers were reluctant to offer homeowners insurance because they feared additional earthquake exposure could potentially bankrupt them. In response to this crisis in the homeowners insurance market, in 1995 California lawmakers passed a two-part bill that allowed insurers to offer a new earthquake policy with a maximum deductible of 15 percent and created a privately funded, state-run earthquake pool.

Earthquake Insurance: Insurers doing business in California must offer earthquake insurance to their homeowners insurance policyholders, either a policy from the California Earthquake Authority (CEA) or, if they do not participate in the pool, a policy that they underwrite. Several dozen companies now write earthquake insurance in California in addition to the CEA. The CEA became operational in December 1996, with a $10.5 billion funding package. The CEA could now pay claims caused by a quake more than twice as destructive as Northridge since with each passing earthquake-free year, its claims paying ability increases. Passage of the CEA legislation opened up the homeowners market (see Earthquake paper). More recently, the CEA created a supplementary policy to broaden coverage. Nevertheless, only a small portion of the state’s property owners buy earthquake insurance and the percentage appears to grow smaller as the time span since the last major quake increases.

Tornadoes: Each year, about 1,200 tornadoes with gusts of wind as high as 200 mph touch down in the United States. Tornado intensity is measured by the Fujita scale, which runs from 0 through 5, the most damaging, based on the maximum speed of three-second wind gusts and the potential for damage. The scale incorporates 28 different damage indicators based on damage to a wide variety of structures from shopping malls to trees. Though generally not as costly in terms of insured values as hurricanes because they strike a more limited geographic area, tornadoes are more frequent. They can cause severe damage and, particularly before the advent of tornado warnings, many deaths. In the decade 1965-1974, they were responsible for an average of 141 deaths each year, compared with 63 in the 10 years 1999-2008. The peak of the tornado season is April through June or July. Spring tornadoes tend to be more severe and strike the Southeast, which is more densely populated than the Great Plains, thus causing more deaths than those in the summer months. In addition, the South has more mobile homes than other regions. Mobile homes are vulnerable to tornado damage.

Since 1990 the number of tornadoes has generally exceeded 1,000 a year. In the three preceding decades, the only year in which there were more than 1,000 tornadoes was 1973, when 1,102 were reported. This increase may reflect greater ability to detect tornadoes.

Wildland Fires: Fire plays an important role in the life of a forest, clearing away dead wood and undergrowth to make way for younger trees. But for much of the last century, fire-suppression policies focused on extinguishing wildfires as quickly as possible to preserve timber and, increasingly, real estate. These policies have led to the accumulation of brush and other vegetation that is easily ignited and serves as fuel for wildfires. In an effort to reduce the incidence of wildfires, increasingly fire officials are promoting “prescribed burns” to eliminate the accumulated debris. In recent years, most of the large fires with significant property damage have occurred in California, where some of the fastest developing counties are in forested areas. However, wildfires are a growing threat in other states, particularly when there is a drought, as more homes are built in woodland areas that were once wild.

The year 2006 set a national record both in the number of forest fires and their size. A total of 96,385 fires were reported and 9.9 million acres of forest and woodland burned, a 125 percent increase over the 10-year average, according to the National Interagency Fire Center. Fifty percent of the fires occurred in the southern section which stretches from Texas to Georgia. In 2005, more than 8 million acres burned. Over the past decade, the number of acres burned has increased as drought, record-setting heat and the build-up of dead trees and undergrowth together with residential development have combined to heighten the risk of fire. According to a University of Wisconsin study, in the West more than 8.6 million new homes have been built within 30 miles of a national forest since 1982.

A scientific study published in the September 4, 2007 issue of the Proceedings of the National Academy of Sciences examined the role houses play in the spread of wildfires. It found that making entire neighborhoods of homes fire resistant slows down the spread of fire. The likelihood of fires spreading from one site to another is dictated in large part by the amount and proximity of fuel—flammable materials such as dry undergrowth, trees that burn easily and unprotected wooden structures. When houses are not fire resistant, they add greatly to the fuel load and potential for the fire spreading because they quickly burn down to the ground. When homes are fire resistant, not only are they less likely to burn but they also act as a fire break, reducing the ultimate size of the fire and enabling it to be brought under control more easily. The Institute for Business & Home Safety (IBHS), a group supported by the insurance industry, is conducting research into how construction, building components, landscaping practices and homeowner behavior play a role in the spread of wildfires, using data from insurance companies that insured structures in the “burn zone,” regardless of whether or not they sustained damage.

Fire damage is covered under a homeowners insurance policy whatever the cause of the fire, unless the person insured under the policy commits arson by intentionally setting fire to the structure. As a result of the greater potential for fire losses where homes are built on mountainous and forested sites, insurers are increasingly requiring homeowners whose property is at risk to take precautions to slow the spread of fire. Such measures include installing fire-resistant roofs and creating a “defensible zone” around the home by removing debris, overhanging tree branches and other items located close to the building that can become fuel for a fire.

Reinsurance: Just as individuals and businesses buy insurance to protect their assets, primary insurers, the companies that sell insurance to consumers, buy reinsurance to protect their bottom line. Reinsurance is sold in layers, reaching up into the millions of dollars to protect insurance companies from possible, but statistically highly unlikely events, such as a $100 million court award or an extraordinary number of homeowners claims as a result of a hurricane or a fast-spreading brush fire.

Retentions and coinsurance, through which insurers share the risk at various levels with their reinsurers, as well as coverage amounts have increased dramatically over the past decade. It is now patently evident that the cost of catastrophes, both natural and man-made, can be in the tens of billions of dollars. Hurricane Katrina cost more than $40 billion but a hurricane hit to Miami or a major terrorist attack could cost much more.

Before September 11, terrorist coverage was provided to commercial policyholders essentially without charge because the risk of an attack was considered remote. Immediately following the disaster, reinsurers said they would no longer offer terrorist coverage to the insurance companies they reinsure because they could not price this unprecedented risk and the availability of coverage for terrorist events is still limited. Legislation that made the federal government the reinsurer of last resort for major terrorist attacks was passed by Congress in November 2002 and extended in 2005 for two more years, making it easier for insurers to calculate maximum losses and therefore to underwrite the coverage (see paper on Terrorism Risk and Insurance). The program was reauthorized by Congress at the end of 2007 for another seven years.

The shortage of catastrophe reinsurance capacity in the United States following Hurricane Andrew, particularly for large national insurance companies, also prompted insurers, reinsurers, investment banks and others to look for new ways to spread the risk of natural disasters (see Reinsurance paper). Increasingly, the capital markets are being seen as a large resource that can be tapped to cover claims at the higher levels (after reinsurance has been exhausted) where there is a low probability of loss. The advantage to investors is diversification. Catastrophe losses are unrelated to the usual speculative risks, which are generally economic. While the number of transactions involving the capital markets is still relatively small, some observers expect catastrophe risk to be securitized and made available to investors on a regular basis.

Pricing: The price of an insurance policy reflects the costs of paying claims covered by that policy, as well as an insurance company's costs for such items as reinsurance. Not surprisingly, reinsurance costs as well as direct claims costs are lower where the risk is low. For example, if a community has a good fire department and ready access to water to extinguish fires, serious fires in that community will likely be fewer than in similar communities that lack a good fire department. The same principle applies to windstorms: premiums will reflect the normal level of windstorm claims in a given community.

How does the insurance industry deal with extraordinary costs such as the $40.6 billion in insured losses for Hurricane Katrina? Prior to Hurricane Andrew, insurance companies accounted for hurricanes and other catastrophes with a special premium amount known as a "catastrophe loading" to spread the risk over a period spanning 30 to 40 years. Sometimes they used data from several states subject to the same kind of catastrophes to develop the average annual cost of catastrophes. However, since the mid-1990s more sophisticated computer modeling techniques have become available. Insurers now base their rates, in part, on sophisticated computer models that combine meteorological data with their own exposure data. The meteorological data show the probability of a natural disaster occurring in a particular geographical area and the exposure data indicate how many of the company's policyholders are likely to be affected and to what extent, i.e., what the insurer's potential losses from that event are likely to be. Models can also assess the losses a specific company or building might sustain in a terrorist attack.

Special Catastrophe Programs: In the United States special pools, known as Beach and Windstorm Plans, ensure the availability of windstorm insurance for properties close to the ocean. These pools, which exist in seven states along the Gulf and Atlantic coasts in various forms, are operated by property insurers doing business in the state, and in some cases by the state itself. Hawaii created a fund but this was disbanded in December 2000.

New Zealand, Japan, France, Norway and the Netherlands also have catastrophe programs. The original program in New Zealand, the Earthquake and War Damage Commission, was enacted in 1944 to cover "uninsurable" risks. Since 1994 the program has covered not only damage caused by earthquakes but also floods, tsunamis, landslides, volcanic eruptions and hydrothermal activity. Funding comes from a levy placed on all fire insurance policies.

In France, the government created a program in 1982 to pay for uninsurable disasters such as floods. It is funded through a tax on nonlife (home, auto and commercial) insurance premiums. Insurance companies can obtain reinsurance for catastrophes from the government-owned Caisse Central de Reassurance.

The Netherlands set up a natural disasters program based on the French system after widespread, devastating flooding in 1994.

Japan has had an earthquake program covering residential properties since 1966. Primary companies sell the coverage but, since it is expensive and not mandatory, less than 10 percent of homeowners purchase it. Primary insurers insure 100 percent of the risk with the Japanese Earthquake Reinsurance Company (JER), a government entity. JER in turn cedes a portion of the risk to the private reinsurance market and to the Toa Reinsurance Company. The program requires a high level of "coinsurance" by policyholders. In the case of "half a loss," for example—damage equal to between 20 and 50 percent of the property's value—only 50 percent of the loss is covered by insurance. The total limit of indemnity payable by all insurers to claimants for any one earthquake is set annually by the Japanese government. If claims exceed the budgeted amount, payments are prorated. The government limits commercial insurance coverage for earthquakes by geographical location, according to the risk of earthquake damage.

Taiwan set up a program for earthquake losses in 2002, under which claim costs are shared among private insurers, the international reinsurance industry and the government.

Spain has a government-sponsored reinsurance pool that covers both terrorist acts and natural disasters, such as floods, but does not offer business income coverage.

Building Code Enforcement and Other Damage Mitigation Measures: In the mid-1980s, a study of the damage caused by Hurricanes Alicia (1983) and Diana (1984), two storms of roughly equal size and intensity, found that the level of building code enforcement affected the cost of claims. Hurricane Alicia hit Texas, causing $675 million in insured damage, of which close to 70 percent was attributed to poor code enforcement. By contrast, Hurricane Diana hit North Carolina, where codes were effectively enforced. Researchers found that only 3 percent of homes in that state suffered major structural damage as result of the hurricane. (Insured losses for North and South Carolina totaled $36 million.) This research and a similar assessment of losses in South Carolina after Hurricane Hugo prompted the National Committee on Property Insurance, now the Tampa-based Institute for Business & Home Safety (IBHS) see below, to study coastal municipal building code departments in southern states. Researchers found that building officials and inspectors in about half of the communities surveyed were not enforcing the building code wind-resistance standards on their books.

In South Florida, which has one of the strongest building codes in the country, experts estimated that between 25 and 40 percent of Hurricane Andrew losses were avoidable. A Dade County, Florida, grand jury report issued in December 1992 confirmed that much of the damage was due to lax code enforcement, warning that it was a long-standing problem in the state and that the quality of rebuilding in the hurricane devastated area might be even lower.

As a result, the insurance industry began to develop a building code compliance rating system, similar to its fire protection rating system, which dates back to 1916. Under the fire protection classification program, each local fire department's firefighting capability is ranked according to various factors, such as water supply and whether its firefighters are fulltime paid employees or volunteers. The final ranking is incorporated into the property insurance premium rate structure. The building code enforcement ranking process takes into account such things as the size of the building code enforcement budget relative to the amount of building activity, the professional qualifications of building inspectors and past code enforcement levels, with special emphasis on mitigating losses due to natural disasters. Insurers can now offer discounts on property insurance for new construction in communities that enforce accepted building codes. Communities are regraded for building code enforcement every five years.

Through the Institute for Business and Home Safety (IHBS) insurers are sponsoring building construction that better withstands natural disasters. Named "Fortified…for Safer Living," the program specifies construction, design and landscaping guidelines for homes (and eventually businesses) in areas subject to windstorms, hailstorms and earthquakes. The current program applies to homes now being built. There will also be a retrofitting program for existing structures. The aim is to have a fortified model home in every county in Florida and then one in every state. In Florida, such houses cost from 4 to 9 percent more to build. Surveys show that on average people are prepared to pay up to 6 percent more for a disaster resistant dwelling.

The concept behind this program is twofold: to keep the structure intact and to protect those inside from outside debris, which turns into dangerous missiles in a storm. The more secure the structure, the less storm-generated debris there will be. Some states are initiating programs to help consumers “fortify” their homes themselves, sometimes requiring insurers to offer homeowners insurance discounts for improvements. Efforts to reduce catastrophe damage are not confined to hurricane-prone regions. Homes in areas vulnerable to other types of catastrophes can be protected also and even if discounts are not offered, hail and wildfire-resistant roofs and measures taken to reduce earthquake-related damage make structures in high-risk areas more readily insurable, and because there is generally less damage, lessen the frustrations involved in getting back on track after a disaster.