April 14, 2015 by Canadian Underwriter
Insurers in the United States should monitor their exposure concentrations with additional risk metrics in light of rising property values in natural catastrophe-prone areas that can increase the opportunity for mega-cat losses, argues a new paper from Karen Clark & Company (KCC).
Increasing Concentrations of Property Values and Catastrophe Risk in the U.S., issued Monday by KCC, notes that property values south of the border have continued to become more concentrated in areas prone to natural catastrophes.
“Residential, commercial and industrial property values in the U.S. continue to increase faster than GDP growth and the general rate of inflation,” the paper states. “The cost to replace residential and commercial properties destroyed by natural disasters has continued to rise faster than the general economy, primarily due to increasing construction costs per square foot.”
KCC estimates that insured property values increased 9% from 2012 to 2014. “In aggregate, building values in the U.S. now exceed US$40 trillion, and when contents and time element exposures are included, estimated insured property values are more than US$90 trillion,” the paper points out.
“Along with increasing values, there are highly concentrated pockets of exposure, particularly in regions vulnerable to natural catastrophes,” it adds.
California, New York and Texas have the most property value, with the Top 10 states accounting for more than 50% of the U.S. total. As well, five of the Top 10 counties are in areas highly vulnerable to major natural catastrophes.
With regard to vulnerability to hurricanes and other coastal hazards, these continue to rise “because of increasing concentrations of property values along the coast. Of the US$90 trillion in total U.S. property exposure, over US$16 trillion is in the first tier of Gulf and Atlantic coastal counties, an increase from US$14.5 trillion in 2012,” the paper states.
The paper advises that probable maximum losses (PMLs) can give a false sense of security. “Insurers typically manage their potential catastrophe losses to the 100-year PMLs, but because of increasingly concentrated property values in several major metropolitan areas, the losses insurers will suffer from the 100-year event will greatly exceed their estimated 100-year PMLs,” it notes.
“The PML risk metrics insurers have been using to manage catastrophe risk do not give a complete picture of catastrophe loss potential and do not reveal potential solvency-impairing exposure concentrations,” KCC reports. Instead, the paper recommends that insurers use new risk metrics – characteristic events (CEs) – for monitoring exposure concentrations.
“The CEs help companies better understand their catastrophe loss potential so they can avoid surprise solvency-impairing events,” the paper suggests. “Because it’s likely that catastrophe loss potential will continue to grow in already concentrated areas, insurers require multiple perspectives on increasing catastrophe risk,” it recommends. [click image below to enlarge]
“Instead of simulating many thousands of random events, in the CE approach, events are meticulously and judiciously created using all of the scientific knowledge about the events in specific regions,” the paper explains. “The same scientific information and data used by the vendor models, are used to develop events with characteristics reflecting various return periods of interest, such as the 100 and 200 year. Once the events are created, they are ‘floated’ to estimate losses at specific locations,” KCC continues.
KCC reports that one implication of greater concentrations of property value is the higher probability of mega-catastrophe losses. “No major hurricane or earthquake has occurred in a densely populated urban centre for decades. When a 100-year type event does occur in one of these areas, the property damage and economic loss will dwarf the losses from Hurricane Katrina and Superstorm Sandy,” the paper states.
For hurricanes, the most likely regions for a 100-year event are Texas, the Gulf and South Florida, where hurricanes are most frequent and the waters are the warmest. By superimposing 100-year events on the 2014 property values, “three regions emerge as the most likely for mega-catastrophes. In all of these regions, the largest losses from the 100-year event are much larger than the 100-year PMLs,” the paper notes.
For example, the 100-year hurricane making a direct hit on downtown Miami will cause more than US$250billion in insured losses today, two times the estimated 100-year PML. “Catastrophe models generally agree that if the Great Miami Hurricane of 1926 occurred this year, the insured losses would be around US$125 billion – in line with the estimated 100-year PML. That hurricane was a Category 4 storm – a Category 5 hurricane would likely cause twice the losses,” KCC adds.