Insurance professionals need to bear in mind catastrophe models are imperfect, and should account for factors such as a concentration of exposures, location of critical suppliers and the time since the last catastrophe occurred in an area, brokerage firm Lockton stated in a recent report.
"Recognize models will always be wrong and there will always be nonmodeled factors," Lockton advises in the report, titled Catastrophe Models: Learning from Superstorm Sandy.
Hurricane Sandy was downgraded to post-tropical storm status when it made landfall in New Jersey Oct. 29, 2012.
"Each catastrophe has unique circumstances that no model will ever capture. For instance, governors of the states impacted by Sandy ordered property insurers to enforce all-other-peril (AOP) deductibles, rather than percentage hurricane deductibles post-Sandy."
The report notes that a $500,000 home with a 5% deductible for hurricane would have a $25,000 deductible, but the all-other-peril deductible for the same home might be as low as $500.
Kansas City, Mo.-based Lockton noted that longer time intervals between events "increase the uncertainty in loss estimates."
It used as an example a series of earthquakes in 1811 and 1812 centred near New Madrid, Mo., on the Mississippi River about 200 km south of St. Louis. One of the quakes was later estimated to be about 7.7 on the Richter scale. Quoting from the U.S. Federal Emergency Management Agency, Lockton said a similar earthquake today "would cause US$300 billion of direct economic damage, while (FEMA) also (suggests) indirect losses could reach $600 billion.
"Insurers would bear 60-80% of the economic damages from this event, due to the relatively high take-up rate of earthquake insurance in the New Madrid region."
According to the U.S. Geological Survey, the earthquakes 200 years ago "rank as some of the largest in the United States since its settlement by Europeans" and "were by far the largest east of the Rocky Mountains in the U.S. and Canada."
Although there were no seismographs in North America at that time, USGS said the shaking associated with those shocks was 10 times as large at the San Francisco earthquake in 1906, adding chimneys were toppled in St. Louis and Cincinnati.
Lockton suggested in its report that a similar earthquake today could result in damage to more than 3,500 bridges and could render 15 major bridges unusable. It could also cause 425,000 breaks or leaks in gas pipelines.
"Pinpoint the location of critical suppliers and infrastructure dependencies," the report advises. "Is your client dependant on a utility company located in a CAT-prone area?"
It also advises insurance carriers to ask about sources of indirect losses, such as power failures and transportation disruption. Another question to ask is whether covered locations are in areas prone to flooding or near a levee in a high-risk area.
"Does your client have a concentration of exposures very near each other, which could easily consume the limits of insurance?"