Quick, what's the definition of a "megacatastrophe," or megacat? The one-word answer is: megabucks.
After $100 billion in losses over the last two hurricane seasons, insurers are finally listening to the weathermen in the industry. Over the next decade or two, hurricane seasons could be as active as last year's, leaving insurers to stare down their coastal exposure and wonder where the next megacatastrophe will hit.
Megacats such as Katrina, says Hemant Shah, president and CEO of the Newark, Calif.-based modeling firm Risk Management Solutions Inc., are events where losses reach a threshold at which they compound across perils, where "amplification factors" turn losses into a mess as murky as Lake Ponchartrain, whose levees broke and flooded much of New Orleans.
Steve Smith, vice president of the ReAdvisory unit of specialty reinsurance intermediary Carvill, says the concept of the megacatastrophe is overblown--a "media overexagerration." Any catastrophe is cataclysmic, he says, especially if it's your home or business that gets pounded. A megacat simply is "a very large catastrophe that hits a major metropolitan area," Smith says.
Whatever you think of them, megacats are expensive, and the risk of the hurricane variety seems to be on the rise.
One half of the explanation for this is increased frequency caused by hotter water in the Atlantic. Some scientists say this phenomenon is tied into global warming, others that it's a result of a natural climate cycle called the Atlantic Multidecadal Oscillation. Though disagreeing on the cause, experts do agree on the result: more active storm seasons ahead.
Now enter the severity side of the equation.
Smith says that severity is driven by randomness to a greater degree than the frequency side of the equation. In other words, it was difficult to predict last spring that the 2005 season would witness three Category 5 storms, all of which (after weakening) made landfall in the United States. Forecasting strength and landfall odds for individual storms isn't going to be any easier in 2006.
But one aspect of severity that requires no crystal ball is the part that coastal property exposures will play in driving up losses of future land-falling storms.
About 38 percent of exposure in Gulf and East Coast states is in coastal counties, according to estimates by the Boston-based modeling company, AIR Worldwide Corp. In Florida, the most hurricane-prone state, 79 percent of all property is in coastal counties.
The consultant firm Tillinghast provides its own statistics on the subject in a report released last October. Prior to Hurricane Hugo in 1989, no storm had cost the insurance industry more than $2 billion. (At the time, Hugo set a record with $4 billion in losses.)
The explanation for this trend, the report concludes, has to do with the increase in the number of properties in coastal areas, rather than with inflation, real property value growth or increased uptake of wind coverage.
Mother Nature has more frames to bowl, with many more pins to aim at, so to speak. Or as Jose Montemayor, managing general partner at Black Diamond Capital Partners and former Texas commissioner of insurance, simply put it at a recent property/casualty conference: "Everyone likes to live on the coast."
January 1, 2006
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