In the immediate aftermath of Hurricane Andrew, some 25 years ago now, I can vividly remember the pictures of Homestead Florida with entire blocks of houses reduced to rubble. At the time I worked at a small reinsurer with around $200M in capital where we wrote a small property cat book with a small net line protected by retro coverage. As a result, from a business perspective, the impact on the company I worked for was insignificant in comparison the destruction we could see in the photos from Florida and the Bahamas.
It took some time for the financial impact of Hurricane Andrew on insurers and reinsurers to become known and I still remember three stories from other companies that illustrate just how ill-prepared the industry was in estimating its exposures to Hurricanes like Andrew and the cat loads needed in the property business to fund the large cat event:
1. What's an occurrence limit? In 1992, occurrence limits on property quota shares were not the norm. There was one program in particular in the reinsurance market that basically was covering shorefront condo and hotel properties in Florida. Several reinsurers suffered unexpected and disproportionate losses as the loss ratio on
this program was uncapped and had a loss ratio that year in excess 300%. Occurrence limits became the norm post-Andrew on any quota share with cat exposure.
2. Where did the profit go? I had a friend at another small reinsurer who said that Hurricane Andrew wiped out all the prior underwriting profits the company had made on property business going back to the early 1950's! It was a shock to realize that a company had spent 40 years underwriting property business all to achieve no underwriting profit. Hurricane Andrew forced companies to more rigorously quantify its exposure to large cat events and determine the kind of underwriting profit it would need to earn during good years to offset the large cat event and still earn sufficient profit over the long run. It also forced companies to better assess the amount of capital needed to support cat business and the required rate of return on a risk adjusted basis. Prior to Andrew, this quantification was not being done with any rigor.
3. The run on the bank: My final story is about a company that during the renewal of its cat program post Andrew was quoted a significant rate increase despite not having any significant Andrew losses. The buyer pointed out to the reinsurer that the company cat program had built up a significant bank of profit for the reinsurers over the years and therefore a large rate increase wasn't necessary. The reinsurer responded that the money in the bank had been withdrawn" to cover the Andrew losses of other companies and that everyone's rates were going up. Both buyers and sellers of cat exposure started to apply more statistical power to estimating catastrophe losses and concepts like "building a bank" or "making reinsurers whole" lessened in importance.
Before Hurricane Andrew, cat models and tracking of cat exposures was in its infancy. Hurricane Andrew provided a strong kick in the pants of the insurance industry to pick up the pace of model building, resulting in the cat models we see today at Swiss Re and elsewhere in the industry. While models are never 100% accurate, they do allow for far more accurate pricing of risk which in turn helps us with our vision to make the world more resilient.
Category: Climate/natural disasters: Disaster risk, Floods/storms