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By RAVI SINGHVI, vice president of analytics at NAPCO LLC, the Iselin, N.J.-based wholesale insurance broker that specializes in catastrophe-property programs

Version 11.0 of the U.S. Hurricane Model from Risk Management Solutions Inc. (RMS) is the catastrophe modeler's first major revision since 2006.

But, she explained, with this latest version, a greater increase in the risk of hurricane damage will be for interior/inland regions, although coastal regions are still the most risky.

There's additional good news for some coastal property owners from the new RMS model: version 11.0 shows decreased average annual loss (AAL) estimates in some coastal areas. An AAL is an estimate of the amount of premium required to balance catastrophic risk over time. This is welcome news to risk managers in these areas, who are finally seeing the benefit of adherence to stringent building codes and mitigation investment; two primary components used in the development of catastrophe model results.

That said, brokers fear any "gains" in coastal areas could be negated by the increased AALs in many inland areas. For example, inland regions in Florida and Texas will see AALs jump as high as 50 percent and more than 90 percent, respectively.

"What we've really learned is that hurricanes weaken less rapidly than we thought," Souch explained. In discussing inland regions, Souch said "Something else we've learned is the degree of vulnerability of older buildings to lower wind speeds. Our data shows increased failures of roofs at a much earlier time during the storm and at slower speeds."

EFFECT ON INSURANCE MARKETPLACE

Souch believes that changes reflected in the new model could start affecting the insurance marketplace later this year.

"You don't just 'switch on' a new CAT model," she was quick to add. "People need time to understand the driving factors."

She also reminded that the model is "just a tool."

"It's up to insurance markets to ultimately decide what they do with it," she said.

Others in the marketplace predict the model's effects on property insurance rates will not be seen for at least one year. Others believe this estimate too conservative, predicting (similar to Souch) that major changes in capacity and pricing could arrive by summer.

The sense from brokers is that this model--coupled with the catastrophic damage still being assessed in Japan--could signal the end of the soft market conditions pervading the industry for the last several years. Many property brokers fear a hasty, knee-jerk reaction to the new model could result in decreased capacity and higher pricing across carrier portfolios in as little as a few months. Even those carriers that sit on the data for a while are likely to incorporate it over time, causing brokers to fear that the several years of flat and reduced pricing are coming to an end.

On the other side, carriers point out that modeling is only viewed as a single component in terms of underwriting.

However, there's no question that model data is used by reinsurers as a measure of capacity, as well as by rating agencies as a measure of solvency.

"Modeling does affect the insurance marketplace. It does affect capacity and cost," said Ranajit Sarkar, a business development executive for RMS competitor AIR Worldwide. "We like to look at it as a supply chain: brokers use models to help place property risks with insurers. Insurers use models to price policies and assess risk of aggregate portfolios. Reinsurers use models at the aggregate level to assist with capacity."

THE PIPELINE

AIR introduced its major U.S. hurricane update in 2010, with more refinements to come this year, Sarkar said.

Sarkar doesn't believe AIR's data will indicate exposure changes at as drastic a level as other modeling agencies. He credited this to AIR's "extensive focus on the entire life cycle of a hurricane"--whereas other models historically focus data primarily on landfall.

"Our models have always focused on capturing the complete storm cycle to quantify inland risk, allowing for inland reintensification, as well as incorporating data on building codes in force well inland of landfall," he explained.

Tom Larsen, senior vice president and product architect at EQECAT, another firm specializing in catastrophe modeling, said that the firm is in the process of updating its Atlantic Hurricane model. An update is expected in June, following the last significant update in 2007.

"Our typical style is incremental updates, but we expect 2011 to be a big release," Larsen said.

Like Sarkar, Larsen said that he expects any increase in structural damage probability related to windstorm and resulting AALs to be "modest."

"The key component of our 2011 model is improving our determination of what direction the winds are actually coming from. Winds circulate so we need to capture exposure from each side of the buildings," he said.

April 1, 2011

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