The times, they are a changin’

In the final part of a series of articles on the differences between models and reality, Robert Medeiros examines how changes in the US insurance market could have a big impact on claims when the next hurricane happens. 

Robert MedeirosCatastrophe models use an understanding of claims from past events to predict the size of future losses. But the insurance market is not static and changes in the economic, regulatory and legal environment will affect the size of future payments. As most cat bonds are now triggered by the actual losses paid by insurance companies, it is more important than ever to understand the unmodelled factors that drive claims.

Robert Medeiros from Lighthouse Consulting has been highlighting some of the issues that can cause a gap between models and reality. In his first instalment he reviewed how the new claims environment in Florida can lead to unmodelled losses. In the second instalment he reviewed the types of policies and policy language that can increase payouts. In this final instalment he reviews the changes in the insurance market that are likely to effect insurance claims after the next major hurricane.

I find myself fighting change. Maybe it is due to an approaching milestone birthday. The saying, “change is the only constant” applies to life as much as it does to the insurance market since the last major storms of 2004-05. Some of these will add to unmodelled loss. The changes are grouped into four broad categories:

  • The economy - A few years after the 2004-05 storm season the US economy went into a recession. New construction virtually ceased, and construction workers left the industry for other careers. The economy has recovered, construction is up, but there is a shortage of experienced workers. In a major storm rebuilding costs would be significantly higher than current valuation software would indicate, and take longer, due to a scarce labour supply.
  • Regulatory - Hurricane  Sandy showed that state insurance regulators are not unwilling to insert themselves in the market to protect their policyholders. They opined that Sandy’s windspeed was not enough to trigger the percentage wind deductible in the policy. They also decreased the time insurers had to inspect and respond to a claim.
  • Legal - A somewhat obscure but foundational principle in property insurance is called Anti-concurrent causation (ACC). The wording is complex but the intent is to exclude coverage for certain perils (such as flood) that happen concurrently with covered perils (such as wind). This language continues to be tested. Some courts have upheld the language, others have not. Some states have rejected it entirely. In truth, when inspecting a damaged property it is not always clear where the wind damage ended and the flood began. It is wise to expect that some flood loss will leak into the wind loss.

As if this wasn’t enough there is also Reverse ACC.   Following Sandy insurance brokers on commercial policies realised that having storm surge included in the flood definition was a disadvantage due to low flood limits. Brokers now try to get storm surge in the wind limit; insurers resist but on large commercial policies they will include it.

  • National Flood Insurance Program (NFIP) - Congress seems content to subsidise primary homes but it hit second homes and commercial properties with large rate increases to obtain actuarially sound rates. Expect private insurers to move into this space as rates increase.

How much should these add to the modelled loss and price? No one knows. My guess is that these increases are not linear with increasing storm size. I would expect the percentage of un-modelled loss to be higher on larger storms.

The goal of this series of articles in InsuranceLinked has been to make investors aware that the model is a starting point. Unmodelled loss is a fact. Failure to consider it can result in underpricing, or worse yet, a false sense of comfort from high attachment points.  The real world is riskier than the modelled world, and stuff happens.

Robert Medeiros CPCU, ARe, AMIM, ASLI is the founder and President of Lighthouse Consulting, LLC,, which provides underwriting audit and consulting services to the off-shore reinsurance market. He can be contacted at

Posted: Monday, May 18th, 2015