<scp>Catastrophe Management in a Changing World: The Case of Hurricanes</scp>

This article features a presentation and discussant comments on hurricane and wind insurance organized by Richard A. Derrig for the American Risk and Insurance Association (ARIA) 2007 Annual Meeting in Quebec City, Quebec, Canada. The moderator, Richard A. Derrig, is President of OPAL Consulting LLC, Providence, RI. Richard formed OPAL after retiring in 2004 from the Auto Insurers and Insurance Fraud Bureaus of Massachusetts. He has published numerous articles on auto insurance, fraud, and other important insurance issues in risk and insurance and actuarial journals. The principal presenter is Jay S. Fishman, Chairman and Chief Executive Officer of The Travelers Companies, Inc., a Fortune 100 company with assets in excess of $100 billion and revenues in excess of $25 billion. Travelers offers a wide range of property and casualty insurance products and services to businesses, organizations, and individuals in the United States and selected international markets. Mr. Fishman was named President and Chief Executive Officer of Travelers in 1998 and Chairman in 2000. From early 2000 until October 2001, he also served as Chief Operating Officer of Finance and Risk for Citigroup, as head of Citigroup's global insurance businesses and head of its consumer business in Japan and Western Europe. Mr. Fishman is an alumnus of the University of Pennsylvania, having graduated with a bachelor's degree in economics, magna cum laude, in 1974 and with a master's degree in accounting from the Wharton School, also in 1974. At the University of Pennsylvania, he is a member of the Board of Trustees, the Board of Overseers of the Graduate School of Education, and the Industry Advisory Board of the Financial Institutions Center for the Wharton School. He serves on the Board of Directors of the National Academy Foundation. Also, he is an active member of the Business Council, a Vice Chairman of the Kennedy Center Corporate Fund Board in Washington, D.C., and a past Chairman of the American Insurance Association. Our two discussants are Professors Joan Schmit and Martin Grace. Joan holds the American Family Insurance Chair in Risk Management and Insurance at the University of Wisconsin-Madison, where she has been on the faculty since 1988. Currently, she is Chair of the Actuarial Science, Risk Management, and Insurance Department in the School of Business. She also holds a visiting appointment with the University of St. Gallen. Dr. Schmit has been active in several important professional associations. She has been an academic moderator for the International Insurance Society and on the Research Committee of that organization. She is a past President of ARIA, the Insurance Society, and the Risk Theory Society. She has served on the board of the Griffith Foundation and is a Research Fellow at the China Center for Insurance and Social Security Research at Peking University. The second discussant, Professor Grace, is currently the Associate Director of Research at the Center for Risk Management and Insurance at Georgia State University. He is an Associate in the Andrew Young School of Public Policy Studies and holds a law degree and a Ph.D. in economics from the University of Florida. Dr. Grace's research focuses on public policy, regulation and taxation, and his research has been published in many economics, insurance, and public policy journals. He is a former President of the Risk Theory Society and a current Associate Editor of the Journal of Risk and Insurance. Richard A. Derrig (Moderator): The focus of today's discussion concerns the tail of loss distributions. The tail is associated with catastrophes, or cat risk, such as the devastation from Hurricanes Katrina, Wilma, Andrew, and others.1 Catastrophes such as these are not just a U.S. issue, but an international issue. Jay Fishman will provide his perspectives on the effect of wind in catastrophic losses while Professors Schmit and Grace will follow with discussions that put wind catastrophes in general insurance contexts. Jay S. Fishman: As we gather here today, the insurance industry is at a crossroads regarding hurricane wind insurance. We, at Travelers, are suggesting that any sustainable solution to this challenge should be provided by the private insurance market, which is ultimately best equipped to handle this exposure. We have a conceptual framework for our proposal that I will share with you today. It is the beginning of what we hope will be a collaborative and comprehensive study, leading to the creation of a private, market-based solution to what is a serious economic challenge. The focus on hurricane exposure has been precipitated not only by climate experts' warnings of an increase in the likelihood of severe hurricanes, but also by a very real increase in demand for coastal property—resulting in the past decade's escalating property values and aggressive development. The 2003 movie, Something's Gotta Give, provided me with inspiration for the title of my remarks today and with an illustration of the lure of coastal property. For those who've seen it, I suspect you may remember the setting; many scenes take place in a home presumably in the Hamptons, right on the ocean, and feature Diane Keaton and Jack Nicholson picnicking on the property's beach. It could easily have been Cape Cod, the Florida Keys, or Hilton Head instead. Well, they say life imitates art. Or maybe it's the other way around. In fact, 55 percent of the U.S. population now lives within 50 miles of the coast, and estimates show continued growth—particularly as baby boomers look to their retirement years and envision the next phase of their lives with sand between their toes. And we're not talking about modest beach cottages. Sprawling homes and skyscraper condominiums are replacing smaller beach bungalows. Planned condominium construction in South Miami Beach alone over the next 2 years, for example, includes more than 2,000 units, each costing between half a million dollars on the low end to $16 million on the high end, and with an aggregate property value of $6 billion. As we develop and build on the coast, we continue to be warned by climate experts who indicate that we have entered into a period of warming ocean temperatures that will likely increase the size and frequency of catastrophic storms. So, take today's very expensive, very congested coastal property, add to it the specter of greater frequency and severity of weather—think of the three hurricanes in 2005—Katrina, Rita, and Wilma—and the equation yields a substantial rise in the risk of significant, perhaps unprecedented, catastrophic losses. As a leader in this industry, we believe we have an obligation to bring thoughtful ideas to the table to suggest how to deal with the effects of our changing climate. With that backdrop, let's take a step back and look at what the past several decades have taught us about the business of insuring wind. As this history is reviewed, four key issues will emerge: insurance availability, insurance market stability, insurer profitability, and policyholder affordability. In the 1980s and well into the 1990s, we had a relatively long period of benign weather and experienced few hurricanes—which many believe to be the result of an Atlantic cooling cycle. Prominent exceptions included Hurricane Hugo in 1989, which produced $6.8 billion of damage (in 2006 dollars), and Hurricane Andrew in 1992, which produced $22 billion of damage (in 2006 dollars) and unprecedented 200 mile per hour winds. It is generally believed that Andrew wiped out all of the premiums collected by the industry on property policies in the state of Florida for all of the years leading up to it. (As a side note, insurers providing homeowners coverage in Louisiana and Mississippi are expected to pay claims in an amount equal to all homeowners' insurance premiums paid in the state since 1981 and 1989, respectively.) As a result of Hurricane Andrew, about a dozen insurers went out of business, which led others to worry about their own company's solvency. Insurers began to reassess their coastal exposures, evaluating the additional amount of capital needed to support the increased risk. This led to price increases in order to maintain a minimum level of profitability. State policymakers became concerned. Influenced by local pressure, some of them established rules and practices mandating that insurance remain available at what now would be considerably suppressed rates, given the significant increase in risk. Insurance companies were faced with a situation where the rules in place before the wind blew—in other words, the rules under which those insurers had based underwriting decisions—were not the same as the rules in place following the storm. Insurers were required to continue offering policies, and thus commit capital, on noneconomically viable terms. This led insurers to be skeptical about writing additional business and committing capital to these areas long term. Price suppression and inconsistent regulations led to the first issue: insurance availability and obtaining the right price for the exposure. Then, between 1992 and 2003, the frequency and severity of named hurricanes in Florida diminished. Questions began to surface about whether 1992's Hurricane Andrew was an aberration. Insurance companies that continued to push for actuarially sound prices, based on a long-term view and with the knowledge that was had a Industry and some had us as or or perhaps how insurance insurance companies to pay they the risk of economic loss as many individuals as to the same of risk and over In this the industry, that the risk was greater than was to price to and to risk over So, the second was of the that insurance companies were to and be at the of the The led to a issue: the right price to wind for a It had that severe weather losses are only over the long term. that should be and the was that could to be out of in any given and in any years, and significant losses could out premiums and from several years or remember that insurance companies are businesses, and they have to private capital to this all the capital have a So, how could insurance companies and in the The of insurance also had a actuarially sound were to be would be many and who would not be to insurance for the coastal they their values had increased This up very concerns about and four is that state and such as the of market has and increased were as of but local to low have them not only the market of first but for all in some the market of only and other the price of coverage and to the And the be a In the of Florida Insurance for example, we are from economic that should a hurricane is not In an hurricane that is that Florida would a loss of billion. this the Florida Hurricane Fund would have a of and would have a of billion. So, in other words, for an hurricane would under many the company would a This could support or individuals or would that all those in and the hurricane losses of those on the the percent of the population not on coastal property would the 55 percent of the population on the has been to in a on the as So, any wind insurance solution to these four stability, profitability, and at the same it to to the that hurricanes state We have seen for a in providing wind as a or as an to the We believe that private insurers should continue to a substantial in providing coverage for wind. of this us to insurance for Our is to a private market the and Atlantic say from to in which the would of wind In this is It is not is it I that this proposal is a in We have all the and we are experts to us the and out the we believe that this challenge between the insurance industry and state and This proposal is an to provide a framework to that and to a to this issue. So, let's our proposal in of the four key issues that have private market hurricane wind insurance over the past several With to the first two issues regarding availability and stability, the Atlantic and would a more for insurers more for would that are actuarially sound and to the of catastrophes the Also, would be with the of a within the that in risk areas would pay more than those in risk Insurers would have greater that regulations would be established for the long would not and and would more to wind exposure in these The would not the risk, would it provide a under this the for a a The would of rules to actuarially sound rates, as well as a of underwriting wind exposure in coastal of a of and policy that the and of and insurers in the of coastal wind States would continue their over the of insurance and accounting of and market insurer in with the and of state policymakers and the National Association of Insurance could in an to the The of the would to of regulation before and after a would to which should in to more us to the issue, which was of and Financial within the insurance for and and losses for only be in the long term. catastrophic or a of in a company over several sound rates, in this of relatively low frequency and relatively high a other words, the of the loss a In order to this we the creation of a policy within the that insurers to to in following significant or losses. should to the concerns of which we period be an for this over which would be an of the would be losses that period were than and would be losses were more than The of this is a of risk, and the of insurance companies and would be at for the affordability. some coastal actuarially sound than In for percent of the are over many of them presumably on and with the of we suggest the creation of for the of insurance to wind the Atlantic and The would be based as by and property value and of wind insurance and would be to those who are to the insurance. way of under the rules of the current a is it is on the suggesting the to has been to as the This is our to the of for this that additional will be required to our would be by increases in for those who in the and who to pay the We that this is a of the would only be available for a In other words, while we to of current coastal would be that after a of or would be available for their insurance. At some individuals to be to their insurance a This proposal back to the of insurance, which is to the risk as many as that are to the same of risk. The proposal the those who are to coastal wind not to those who are as a by the American that percent of were of for insurance that coastal and percent of that has a deal of in the following Hurricane is the of on what were by and by the National Insurance and what were by and by the private wind insurance has in could be the of for our we would suggest that the creation of the may us an to provide more regarding what is by the private market wind insurance and what is by the of how are to wind or we believe it's important for who the and in areas to insurance and wind insurance. In we that to a changing climate a comprehensive that will committing to construction and the of coastal development. As an important of our insurance we risk is the and of that expected for construction and As a the insurance industry the for Business and to coastal in and construction and that The of and other home should be to our coastal would be to they a and is that would a For coastal have been to a by up and the of the storm. these areas an exposure to wind and losses a storm. regulations that take into the of and the of coastal provide long-term to With of coastal property from to the insurance challenge by the of hurricanes and risk are issues to the economic of the United We are and the with insurance and to our We believe this proposal a for offering wind insurance on our that the of the in to coastal wind exposure is to for and to The of insurers is to individuals their and their to their coastal property. to those we will best be to the of coastal and Professor Martin I about whether or we out of this that we have been I will about is the cat risk and several the how to cat risk and provide a insurance well and are in homeowners insurance, they are not as as they Hurricane Hugo this market, and the of Hurricane Andrew a of hurricane risk and homeowners' insurance to changing was not by to the So, for example, Florida in the market to the and availability by of homeowners' insurance risk in that been in the Florida homeowners' insurance market, would now be insurer capital would be available for and a very homeowners' insurance market would In other words, had been in Florida in the that now in the Florida homeowners' insurance market just be today. the state of Florida became the insurer in this market in the with the level of risk the state of Florida began high risk policies to insurers the to that risk. insurers up which were to with in on homeowners' risk. The end result was market in homeowners' insurance the state of Florida is the insurer in and its is of a for the market for homeowners' insurance. has between insurers and and between and For example, insurance and the price that were not of the is that between price on of risk and this is how we became into a with to this I believe that a market had been to years we would not have a now that is not on the table at this the proposal is a second best the proposal is not the only proposal some of these other proposal is for the to all cat and insurers would just homeowners' insurance to losses those to cat risk. This would the of insurers a for homeowners' insurance that is to all of its and proposal would have the wind and risk and to the National The of is that it about whether a loss was by wind or and would what their coverage consumer for some or all of the insurers are required to all cat any of from state or insurers are required not to high or high insurers are required not to hurricane to or insurers are required not to the proposal which I this the state the private homeowners' insurance market by underwriting this risk This proposal is to all those who the insurance industry and believe that the state a the has been many in Florida. The proposal has several over all of the It rules all and for for the wind It the for to between low in some and coverage in other of the proposal is the losses are than is risk to the are for insurance for those who it, and these are property with to is that they are to phase out they are put in it is to believe that this proposal would result in a of that will result in property this is a I believe that the proposal is a given the the homeowners' insurance market is It an to cat more with It for to price regulation or may whether it will or price for of is the risk that in the will to the proposal that the very from the Joan for this at our is to the of industry and The issues are as Mr. Fishman and Dr. Grace in their We have of in the past to with ideas for the comments will focus on the on research about property catastrophes, and areas for For the Mr. Fishman and Dr. Grace to comments will take this For all of I believe the is to for of property which economic for and beginning may be the 2007 which the of in providing insurance coverage wind damage in the In evaluating the insurance market for wind damage following the 2004 and hurricane the and of in insurance, and more of to the of that has and will from the of our for have the National Insurance a to as hurricane those individuals are and who suggest that may the of the by of insurance. they insurance demand in areas with greater of the that availability of This second We would that individuals who are risk would in and insurance for the exposure. Research on an for these to the of risk to loss with greater of for have been by the wind we more on how to greater such as and their to the effect on insurance. As Hurricane Andrew taught are to is just as important as the The of an of the of Richard and many others have the of insurance Mr. for a is and we should the and of such a is that of regulation that on a and Pennsylvania, for have and auto they to follow in other the also to very The auto is for a of the of in and for these From the some have and others have not some have been and others have and The insurance is where a deal of research For example, has that insurance suppression will and ultimately prices, to the The availability of may be insurance has been and the of such others have the Insurance Research who of claims provide for the effects of the on and of and the and insurer these are and are not up to be in academic of the best to industry and is available for insurance with for has in important on and In the property we may also that are accounting how is in and whether or not long-term for property losses are of the on insurer practices by Grace, Grace, and many others may In to these Mr. Fishman also about on risk of it suggesting that are not at under out the Journal of Risk and Insurance in my I an article by the of several of that risk and insurance are not risk is not associated with a likelihood of insurance. a of research by and a by and Richard to this and that their exposure to catastrophic and This in is not all that given some by and in other have a of where not only but also inconsistent with expected for other than is not to under As a and will not and also that having the provide for those by for in perhaps a that should the of the to policymakers and are by and to risk and evaluating a solution to risk is a that on many of are several in which us to risk to cat risk. important way is to share who have issues of to industry should out to industry to share their industry should look to to on of to our is to share Insurers of that be for the those available to will to greater of issues and and likely to a more of the of property catastrophes, and industry should to develop ideas for at two of the risk and risk and its effect on industry to In such as in which loss by on more risk, are The was an of 50 percent academic and 50 percent with over in In more has to about that size and is between industry and within to have over the This presentation will to be just of many industry and in that to for the of our

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