Hurricanes and FloodsInsurance Responses

And, Sandy

ACTUARIAL ISSUES

Stuart Mathewson, FCAS, MAAA, CPCUSr. Property Actuary, Swiss ReCo-Chair, AAA Extreme Events Committee

MAAC Fall MeetingThursday, September 12, 2013

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Hurricane Modeling Hurricane Insurance/Reinsurance Flood Insurance - NFIP Hurricane Sandy Questions and Answers

Agenda

What? Computer simulation of catastrophic events Run against a portfolio of property risks Gives an estimate of how much loss will be

incurred in the event Somewhat “black box”

WHAT is Cat Modeling?

Why? To estimate potential loss to a company To determine pricing of cat portion of account Much better than previous approaches

◦ Low frequency/High severity events◦ Actual data is nearly useless◦ Industry-wide use promotes market stability

WHY Do We Use Cat Modeling?

How Four modules

◦ Science 1 Simulates a cat event (e.g., hurricane)

◦ Science 2 Calculates the loss drivers (e.g., wind speed) at the

various location affected◦ Engineering

Estimates damage to structures from the event◦ Financial

Calculates insured loss from the damage Library of possible events, with probabilities

How is the Cat Modeling Done?

Brief explanation of hurricane modeling

How is the Cat Modeling Done?

Central Pressure

Forward Velocity (VF)

Rmax

Landfall Location (LF)

Hurricane Hugo

Angle of Landfall (a)

Track

Definition of a HurricaneKey Parameters

x

Eye

An Average of 1.66 Hurricanes per Year in United States

Cat 5Cat 4Cat 3Cat 2Cat 1

Extreme Hurricane on Average Every 5.8 Years

Cat 5Cat 4

Hurricane Strikes by RegionRecorded Landfalls(1899-1996)

Northeast

Mid-Atlantic

Southeast

Florida

Gulf

Texas

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34

63 353

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Hurricane Modeling Methodology

Assess WindField

Calculate Damage

Define Hurricanes

Quantify Risk

Science -Stochastic

Event Module

Science - Hazard Module

Engineering - Vulnerability

Module

Financial Analysis Module

Determination of key hurricane variables◦ Central pressure

◦ Radius of maximum winds

◦ Forward speed

◦ Landfall point and direction

Probabilities of each storm

Define Hurricanes

Modeling Windfields from Hurricanes

150 + 150 - 140140 - 130130 - 120120 - 110110 - 100100 - 9090 - 8080 - 7070 - 6060 - 50

Peak Gustsin mph

Maximum windspeed experienced from Hurricane Hugo 1989

Terrain Effects on Windspeeds

ALarge City

Center

A-Metropolitan

Center

B-, B, B+High/Low Natural

Cover,Dense/Sparse Suburb

COpen Area with

low naturalcover

DTotally

unobstructedcoastal area

Alt

itud

e

Windspeed

WIND

V gradient

V 10 meter

Z gradient

Surface roughness and fetch affect wind speed estimation. Rougher terrain causes larger frictional effects on the windspeed .

Hurricane vulnerability curves represent the relationship between wind speed experienced and damage caused to the buildings

010203040506070

Wind speed

Mea

n Da

mag

e Ra

tio (%

)

Vulnerability Curves

Insurance or reinsurance losses can be calculated from different financial perspectives including: Ground-up, gross, net after reinsurance, catastrophe reinsurance cover

Attachment points for can be specified at location, policy, account or portfolio level

Model takes into account all affected properties in a given scenario

Financial Analysis Model

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

TX LA MS AL FL GA SC NC VA WV MD DE PA NJ NY CT RI MA NH VT ME

Modeled Hurricane Risk by StateAverage Homeowners’ Rates

Model Input Location of building Construction Number of stories Year built Occupancy Secondary characteristics

HOW Do We Use Cat Modeling?

Model Output Annual Average Loss (AAL) Standard deviation of AAL (SD) PML levels

◦ E.g., 100-yr◦ That is, how much loss do we expect with a

probability of 1%?

HOW Do We Use Cat Modeling?

HOW do we use Cat Modeling?Example of PML Curve

Critical Prob. Return Period Loss0.01% 10,000 30,785,9730.02% 5,000 27,309,2930.10% 1,000 19,097,0330.20% 500 15,501,2770.40% 250 12,145,3850.50% 200 11,112,4321.00% 100 7,736,2552.00% 50 4,323,3154.00% 25 1,407,89210.00% 10 18,43320.00% 5 350.00% 2 0

Pure Premium 344,442Standard Deviation 1,649,120

HOW do we use Cat Modeling?

Pricing needs to include provision for the cost of potential loss

Plus a load to pay for the risk◦ For the capacity we have to allocate

for the potential loss◦ For the riskiness in having

accumulations in hazardous areas◦ For the volatility of frequency of loss

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Price based on◦ Location

Susceptibility of the area Distance to the coast

◦ Construction Terms

◦ Higher deductibles – often percentage of value Market

◦ Near coast, often many companies exclude wind loss◦ Wind pools are prevalent

Flood (including storm surge) is almost always excluded◦ Leads to issues of which peril caused the loss

Hurricane Insurance & Reinsurance

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◦ Property insurers determined long ago that flood was not insurable

◦ In 1968, Congress passed an act to establish NFIP

◦ By 1973, most communities were up and running

◦ Some key points Flood insurance available only in communities that

established mandated controls Buildings built before establishment of flood maps

were charged subsidized rates Program needs to be re-authorized periodically Later laws mandated insurance for properties with

federally insured mortgages

Flood Insurance – National Flood Insurance Program (NFIP)

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◦ Some key points (cont.) Intent is that program be self sufficient In years that losses and expenses exceed

premiums, NFIP can borrow from Treasury Until 2004, NFIP was able to pay back Treasury in

non-catastrophe years Until 2005, borrowing limit was $1.5b After Katrina, limit was raised to $21b After Sandy, limit was raised to $30b Current debt is $24b Current annual premiums about $3.5b Full-risk ("actuarial") rates vs Subsidized rates

Flood Insurance – National Flood Insurance Program (NFIP)

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Previous Flood authorization expired in 2008 AAA Extreme Events Committee started work on

paper to address flood issue Congress took 4 years – and numerous short-term

authorizations to pass new law The National Flood Insurance Program: Past,

Present...and Future? – 2011◦ Purpose was to educate on the Flood program to aid

in the public discourse◦ Primary audiences

Actuaries Decision makers

Brief background – AAA involvement

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Capitol Hill briefing on monograph (July, 2011) Comment letters and written testimony to

Congress when deliberations were ongoing (e.g., 6/28/12)

Presentations to NCOIL and NAIC (2011,2012)

Brief background – AAA involvement

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Phases out subsidies for second homes, businesses and severe repetitive loss properties (25%/year)

Any policy for property not currently covered must pay "actuarial" rates

Raises cap on annual increases from 10 to 20% Sets up reserve fund Requires NFIP to set up a schedule to repay debt Requires several studies by GAO, Treasury and

others

Biggert-Waters Flood Insurance Reform and Modernization Act of 2012

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Conversation with GAO on privatization One of the studies mandated by Biggert-Waters Discussed general actuarial views on privatization

Comment letter on HR1035 Community-based Flood Insurance

Current Events

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Why was flood deemed uninsurable? Only those who would often get flooded were

interested in buying it Premium for those properties alone would be

prohibitive Small premium base wouldn't support catastrophic

potential

Privatization

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Do past issues still exist? Current situation

No one stepping in to profit from this niche Some companies offer excess coverage on high valued

properties Large commercial properties usually covered in all-risk

policies Few buy NFIP insurance unless forced

And, enforcement not consistent when mandated Can new technologies help? Wharton/CoreLogic Study

A Methodological Approach for Pricing Flood Insurance & Evaluating Loss Reduction Measures: Application to Texas

Privatization

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Can it be properly rated? And would those rates be sustainable in the market? Expected Losses can be estimated by models Much more granular rating than NFIP NFIP has no capital requirements – therefore, no

capital cost load – private companies would need a significant load

An estimate has been made that rates would have to be roughly doubled if written privately

Can it develop a broad base? Without a mandate, it's hard to foresee increase in

take-up rates

Privatization

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Can these mechanisms be used to support the NFIP? At current rate levels, there is little premium to

cover the cost of private reinsurers Could Federal government act as reinsurer instead

of simply a lender? One idea – Federal government pays for private

market reinsurance Would provide a stable expense for the government Private/Public partnership in vogue now for some Politically viable?

Reinsurance or Capital Markets

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Can these mechanisms be used to support a private market? This could be a key piece of privatization – but

requires enough premium to pay for the reinsurance

Reinsurance or Capital Markets

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HR1035 – mandating a study on community-based flood insurance What does this envision?

Community is the insured Risk assessment and pricing for community as a whole Covers all properties in the community

Pros as per sponsors Streamlined underwriting Increased participation Incentive for community-based mitigation

Issues How do you decide how the taxpayers pay? How do you get individual communities interested?

Community-based Flood Insurance

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At current rate levels, it would take decades to repay debt – even without further major occurrences After Katrina, about $20B – paid down to $17B+ by

2011 After Sandy, up to $24B

Biggert-Waters requires FEMA to create a repayment schedule Must submit to Congress a report on options to

eliminate debt in 10 years

Should the Debt be Forgiven

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Reserve Required by Biggert-Waters

1% of "total loss potential" in force Fund at 7.5% of reserve ratio until capitalized If NFIP unable to make the minimum contribution, it

must report this to Congress How is this to be paid for?

Should the Debt be Forgiven

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Hydrological model Basis for NFIP rates

Probabilistic models Even more difficult to model than earthquake Needs data at a very small granular detail for a large

area of the country Changes to river basins often change significantly Not currently as useful for US insurers as for Europe

Flood Modeling

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Weird storm Hurricane or not? Flood/Wind/Earth Movement Issues

Legal Legislative/Political NFIP

Sandy

Historical Storm Tracks

Cat 5Cat 4Cat 3Cat 2Cat 1

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41

42

43

44

45

46

47

48

49

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As we have seen in the maps, it is very rare to have a storm curve into land in New Jersey

NASA study Typically, the tropical storms and hurricanes that strike

the Northeast are pushed in a northeasterly direction by the prevailing upper level winds

Most storms hit the coast at a grazing angle, and only areas of land that stick out into the ocean, such as Cape Hatteras, N.C., and Cape Cod, Mass., have a long history of experiencing storms that hit at a perilous perpendicular angle.

But with Sandy, the combination of a storm diving southeast from Canada, into the Midwest, and a large high pressure area in northeastern Canada and southern Greenland pinned the storm and forced it westward into the East coast

Weird Storm

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NASA study The study found that Sandy’s track stands alone in the

historical record dating back to 1851, and that modeling simulations showed such a track is an event that would occur about once every 714 years

"... Either Sandy was an exceedingly rare storm, or our assumption of long-term average climate conditions is erroneous, and Sandy’s track was made more likely by climate change in a way that is yet to be fully determined"

The impact angle of Hurricane Sandy was its most unusual feature, ensuring the storm surge would case maximum damage, Hall said. The storm's left-hand turn put the most dangerous right-front quadrant on top of New Jersey and southeastern New York, pummeling these areas with an historic storm surge and record high waves. That, combined with astronomical high tides, led to record storm tide levels.

Weird Storm

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Weird Storm

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Just before landfall, NOAA reclassified this as a post-tropical storm.

This meant that policies with hurricane or "named-storm" deductibles (generally percent deductibles) had to revert to the base deductible in the policy

Hurricane or not?

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One normal issue in a hurricane is the determination how much loss is wind and how much is water (storm surge or flood)

In Sandy's case, much of the damage was cause by water since the wind was not quite hurricane-strength and the storm surge was catastrophic

Normal situations for losses on the coast If there is flood insurance on the property, the wind

carrier and the NFIP have to agree who pays what If not, the wind carrier has to determine how much of the

loss is wind, while the insured is looking to maximize his payout

Flood/Wind/Earth Movement

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One additional issue in Sandy was the assertion by insurers (following NFIP guidelines) that some of the damage not caused by water was caused by earth movement, which is typically excluded

Flood/Wind/Earth Movement

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Legal Legislative/Political FEMA NFIP

Other Issues

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Non-insurance questions – for example Tenants flooded out of their apartments wanted to know whether they

had to continue paying rent. Homeowners needed to figure out who was responsible for removing

toppled trees. Workers at shuttered businesses weren’t sure if they were still entitled

to paychecks. Insurance Questions

Uncounted numbers of residents of New York, New Jersey and Connecticut are challenging flood insurance settlement offers that they believe didn’t properly cover damage.

Some homeowners hired their own consultants to get insurance company adjusters to revise damage estimates.

If the insurer refuses to budge, claims can be appealed to the Federal Emergency Management Agency, which oversees the National Flood Insurance Program.

Legal

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Early on, governors in NJ, CT and NY proclaimed that this was not a hurricane, so hurricane deductibles would not apply.

Most legislative actions dealt with relaxing regulations about assessments, reserve funds, bonds, etc.

Legislative/Political

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Small grants to get people back in homes Any other aid is in form of low interest loans

FEMA

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Claims Issues Congress raised borrowing limit to 30b, assuming

a payout of about $13b Actual payout about $9b

NFIP

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Questions and Answers