COVER STORY, OCTOBER 2006

IMPACT OF CATASTROPHIC LOSSES
Catastrophic losses and their impact on the insurance industry and you.
Robert D. Odell, CIC

Odell

In the world of insurance, catastrophes are significant, rapid and unexpected events characterized by extreme force and/or sizable financial loss. Catastrophes can be man-made, such as the World Trade Center bombing, or natural, such as Hurricane Katrina.

Common Catastrophes

According to the International Insurance Institute, in the last 20 years, hurricanes and tropical storms have been the most frequent types of catastrophic events in the United States, making up 34.6 percent of total catastrophic losses. Losses by tornadoes make up the second most frequent catastrophic loss with 30.4 percent, followed by terrorism at 9.7 percent, winter storms at 9.7 percent, earthquakes at 8.4 percent, wind/hail/flood at 3.4 percent and fire at 2.9 percent. Civil disorders, water damage and utility service disruption represented less than 1 percent of catastrophic losses.

There were 28 named storms in 2005, which not only broke the record for named storms in one season, but also made it the most costly year on record for the insurance industry with $61.2 billion in catastrophic losses for the year.  The impact of losses of this magnitude has had dramatic effects on the insurance industry and has forced immediate changes in appetite and availability.  

We are still in the height of the 2006 hurricane season. The Northeast has not suffered a direct hit in decades. However, weather forecasters have predicted that the Northeast could be a likely hit this year particularly after the very active season in the Gulf of Mexico last year. Contributing factors include the unusual temperatures in the North Atlantic and certain ocean currents which can be indicative of an above average number of storms to come.

Effects of Catastrophes

Insurers have scaled back the availability of property insurance in coastal areas and premiums have skyrocketed. In addition, they have redefined risk areas. In Florida alone, the entire state is now considered coastal. In the Northeast, coastal areas are also feeling the pinch of reduced coverage, no coverage or astronomical increases in premiums. Commercial properties, as well as homeowners, in these areas are being affected.  

This is being driven by the fact that reinsurers took very large hits with the catastrophic losses of 2005. They are carefully evaluating losses and are adjusting their premiums accordingly, including increasing their rates for risks in coastal areas.

Insurers are seeking to make policyholders pay their fair share of the costs of catastrophes by creating higher deductibles. For example, wind deductibles are being set at 2 percent to 5 percent of the insured value of the property. They are also basing rates for windstorm coverage on a structure’s ability to withstand damage by high winds, which is calculated using computer models.

In addition, some coverages are being excluded or smaller limits are being offered, such as earthquake coverage in California. In response to catastrophic acts of terrorism, insurers have added premiums for terrorism coverage and they are careful of their risk exposure in certain geographical areas such as New York and Washington, D.C., and near high-risk terror targets such as bridges and public arenas. 

Be proactive

For the commercial real estate owner, this means that your cost of doing business in certain areas will rise exponentially, too. It may also mean that you may have to think creatively and be proactive about the management of your risk. You may think about assuming some of your own risk if coverage is not available or if it is too expensive. Recently, one very large national retail chain dropped windstorm coverage due to the high premiums and is self-insuring for this type of loss. 

You should take the time to review your property insurance program. As a matter of fact, many lenders have requirements in mortgage agreements to review coverage and limits every 3 to 5 years. First, you want to determine if your current property insurance program provides flood coverage. In addition, you want to evaluate if any of your properties are in flood zones. Flood plain maps are redrawn periodically in response to run-off pattern change and flooding in areas that were not considered high-risk. Secondly, you should review your policies for the other catastrophic coverages such as wind damage, earthquakes and terrorism.

In addition, you want to examine your policies and properties to reevaluate the values. Being underinsured can cost you in two ways. One, you can receive a coinsurance penalty, or two, you may not have enough insurance to cover your loss. You also want to make sure that your business income, namely rents, would be adequately covered should one of your properties suffer a loss. Check your policy to see how long your period of indemnity is. An increased period of indemnity can extend the usual timeframe allotted by a standard insurance policy for which to recover business income losses that were caused by a covered loss.

Construction costs have increased significantly in the past few years and are still rising. Prices for I-beams, channel beams, cement, copper, gypsum, wallboard and petroleum-based products have experienced recent spikes. This increased cost of construction products translates into increased costs to repair buildings damaged by catastrophes.  

The major insurance carriers that provide property coverage to real estate organizations and other types of businesses are requiring that buildings in portfolios be revalued. The reason for this is that it would cost so much more to rebuild if there is a loss. This can significantly increase your property premiums even if you are not located in a coastal area. However, as a real estate owner, you would want to make sure that you have adequate coverage for your portfolio.

Another hedge against possible catastrophic disaster is the development of a disaster recovery program. If there is a catastrophic disaster, you want to ensure that you can preserve your business records and get your business up and running. 

You cannot control the catastrophic disasters that may come your way, but you can control and manage your risk and protect your portfolios by having adequate insurance coverage in place should a catastrophe strike. An experienced insurance broker that specializes in real estate can assist you in your evaluation and planning.

Robert D. Odell, CIC, is president and chief operating officer of LyonsOdell in Radnor, Pennsylvania.

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