By Daniel Hays
Already facing problems from shrunken budgets, many coastal municipalities and their inland neighbors are now finding that a major hurricane damage model, released last year, means renewing their insurance coverage involves big rate jumps and coverage decisions of increased complexity.
Insurers, risk managers and a major broker say that towns and cities have been hit from all sides. Local governments, experts said, are being forced to take gigantic deductibles or double-digit premium increases, look for ever greater numbers of underwriters to participate in coverage, and even consider new frameworks for handling risk to help them deal with insurers who are cutting capacity.
Some experts -- not all -- when considering the market for municipal coverage, also said that they have seen a huge drop in municipal construction activity, and at least one expert thinks the impacts from deferred maintenance to elements of towns' and cities' infrastructure are just around the corner.
While a variety of catastrophe models have gone through revisions following Hurricane Ike in 2008, the one that market participants point to as having the most current effect is U.S. Hurricane Model 11.0 released in February 2011 by Newark, Calif.-based Risk Management Solutions. Its impact is being felt now as municipalities renew their coverage.
The RMS model, for some towns and cities, raised the expected maximum probable loss for a 250-year event anywhere from 25 percent to 300 percent, said Boca Raton, Fla.-based David Marcus, managing director, public entity and scholastic practice and South Florida area president for Arthur J. Gallagher & Co.
In his opinion the RMS model has gone "180 degrees too far -- statistically it doesn't make sense."
Alfred J. Moran Jr., director of the Houston Department of Administration and Regulatory Affairs, said his city, the fourth largest in the U.S., had seen its rates go up fifteen percent "mostly because of RMS 11."
However, Houston obtains its insurance through Lloyd's syndicates and Moran said insurers there told Houston officials that if they were to use the RMS 11 model, "no one would be able to afford insurance." In his mind the Houston rate is actually only up 5 percent, because, he explained, it was down by 10 percent last year.
Moran said Houston has found it is best not to jump around looking for coverage. By sticking with one group of insurers, he said, the city is likely to be treated fairly after a loss. He would advise a municipality, in the wake of a catastrophe, "If you have a loss, for god's sake don't hire a public adjuster." His city did after Hurricane Ike, and the high estimate so inflamed the insurer that Houston almost lost its coverage, he said.
While not all insurers use the latest RMS modeling projections, many do and financial rating firms demand that carriers have the wherewithal to withstand the maximum loss estimated for the business they book.
"A lot of the insurance companies, because of what RMS said to them, have had to contract the amount of insurance they are willing to offer," Marcus said. Carriers, he said, are trying to get rate increases, while at the same time shedding capacity. "Everybody is pushing for the rate," he said.
Claire Souch, London-based vice president of model solutions for RMS said the biggest increases in hurricane loss projections were in areas further into the coast extending, for example, "way into central Texas."
Coastlines are "vastly more risky," she said, but now the difference with interior areas is a little more even. The RMS model, she said, wasn't pulled out of thin air. It was the product of a partnership with the University of Miami and involved running "many, many storm simulations" that provided new insight into damage as hurricanes move into interior areas, Souch said.
Also factored in was a study of construction quality and building components. Souch said that engineers found that in the Gulf of Mexico areas, humidity and a lot of sunshine meant some building materials were deteriorating faster than they were designed to, and that some 10 to 20-year-old buildings "are more vulnerable than they really should be."
Souch conceded that "models are models," and that there's always uncertainty and difference of opinion about them, but said that RMS has "the biggest database that exists anywhere that is used to test the model." The firm is open to discussion of more judgment-based elements of the model, and if companies have data that RMS has not had access to, the organization will consider it, she said.
Marcus said that after Hurricane Andrew hit the Eastern Seaboard in 1992 everything changed for coastal communities. The communities had to increase the number of insurers they use by orders of magnitude.
Whereas before Hurricane Andrew insurance programs covering complex risks often resorted to one, two or even three carriers, post-Andrew insurance programs often employed as many as 20 carriers for the most complex risks, he said.
Now, because of higher loss projections from rain and flooding to inland areas, cities like Houston, whose downtown is located about 60 miles from the coast, must scramble to find coverage.
Moran's city, with 2,200 structures and 625 buildings with $10 billion in value, has had to take $20 million in deductibles on $150 million in insurance. Because it is judged to be in a hurricane path the city "had to go to international markets and piece together a syndicate of 12 insurers and they take different layers," he said. "We have five different risk levels all done at Lloyd's."
Matt Hansen, director of risk management for the city and county of San Francisco, said that for a municipality like his, one not judged to be in a wind zone, property insurance rates have been fairly stable. His description is supported by Jamie Miller, managing director of Swiss Re North America Property, who said that "for the noncatastrophe-driven municipals the market is pretty reasonable with moderate prices."
Miller said Swiss Re, as a worldwide player with a strong technological history and global loss data, does its own calculations and does not use the RMS model. Swiss Re has seen a dramatic increase in what municipalities are spending for coverage on contingent liabilities, from catastrophes such as fighting fires, to emergency expenses following a disaster.
In reaction, Swiss Re is offering different products such as parametric coverage, which triggers covered when specific conditions are met.
Some parametric arrangements, as explained by AJG's Marcus, involve "CAT in a box" protection within a set of geographic coordinates with coverage triggered by barometric pressure levels or wind speed. An event would generate different payouts depending on the level that is reached. He said such cover could be expensive, and that currently municipalities that have taken Federal Emergency Management Agency funds are barred by federal rules from using such coverage.
The soft market has pushed property/casualty insurers' income down as well, so underwriters have a tough balancing act, said Dave Eiser, a senior vice president with Munich Re.
The Munich-based reinsurance giant knows that municipalities are squeezed, and the reinsurer works with them to provide structures that minimize impact. Still, the reinsurer has to try and turn a profit from its underwriting, and "we still have to have pricing," Eiser said.
He also said that in a soft market it was hard to get pricing levels high enough to cover the exposure and to keep up with lost-cost inflation. Inflation is a key factor in the marketplace, Eiser also said.
Erik Nikodem, Lexington Insurance Co.'s senior vice president and property division executive, said his firm tries to retain coverage by offering clients higher deductibles as an option. To keep the business, his firm works to communicate with accounts "far more than we did in the past," he said.
In Tampa, Fla., Kimberly Crum, the city's director of human resources, said a decision hasn't been reached on whether to take higher deductibles. "It's possible, but at this point I'm not sure," she said. "You have to ask, what's the worst I can afford?"
Tampa, she said, has found it can reduce cost by obtaining separate coverage for its waste water treatment and water production buildings. Both structures are built of hardened concrete and are therefore seen as better risks with lower exposures.
Like some other officials with responsibilities in municipal risk management, however, she said she did not see deferred management as a problem.
Nikodem said he could not say the company has seen municipalities failing to maintain property, "but it's a difficult thing."
Robert Hartwig, Insurance Information Institute president and economist, said he suspected there has been a lot of infrastructure deferral. Roads, bridges and schools are in worse shape and "you could have a catastrophic failure -- something like a bridge or leakage through roofs when there's a severe storm," he said.
Hartwig said the need for insurance coverage of municipal construction has fallen off sharply as the recession has battered the construction industry.
DAN HAYS has written for newspapers and magazines for more than 30 years. He can be reached at email@example.com.
June 1, 2012
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