Can the Florida Insurance Market Withstand a US$100 Billion Repeat of Hurricane Andrew?
Hurricane Andrew’s landfall in Florida in 1992 changed the face of property catastrophe insurance and kick-started many new initiatives, including the development of hurricane risk modeling. However, with significant exposure growth, the impact of social inflation, and climate change complications, the insurance market could struggle to respond to a repeat of Andrew. The wide-ranging impact of Hurricane Andrew on the Florida insurance market is a familiar story within the risk management world. However, 30 years on from August 24, 1992, when Andrew made landfall in Dade County, Florida, memories appear to be getting shorter, as the insurance industry once more seems to be in danger of underestimating its exposure to a Category 5 storm hitting the state. Image from the GOES-7 satellite shows Hurricane Andrew at its peak intensity on August 23, 1992, before making landfall near Homestead, Florida. Image source: NOAAWhen Hurricane Andrew came ashore as the first named tropical storm of the 1992 North Atlantic hurricane season, it followed a seven-year hiatus in major hurricane activity in Florida. Industry predictions at the time were that it would cost insurers around US$4 billion to US$5 billion, but Andrew ended up costing the insurance industry US$15 billion (in 1992 values) for Florida claims, and it caused the deaths of 44 people in the state. Following Hurricane Andrew, more than 650,000 claims were filed, leaving eight insurers becoming insolvent and a further three driven into insolvency the following year. Fast forward to today, and RMS® predictions for a repeat of Andrew would see the insured loss for wind and surge in the range of US$80 billion (GR) and US$90 billion (GU), in which other non-modeled losses and social inflation could lead to a US$100 billion event. Aftermath of Andrew The losses from Hurricane Andrew vindicated the need for catastrophe modeling solutions including the use of multiple simulated storms beyond those previously experienced in history. Catastrophe models enabled the new Bermuda reinsurance market: eight new reinsurers were established without the need for their own historical experience. In time, catastrophe models would enable the creation of insurance-linked securities such as catastrophe bonds, to tap into capital markets for alternatives to reinsurance. Without Hurricane Andrew, it might have taken much longer for this revolution to happen. The crisis caused by Andrew certainly precipitated some rapid and innovative changes to help manage a much larger hurricane risk cost than previously recognized, allowing the market to prepare for the hyperactive Florida hurricane seasons of 2004 and 2005. However, the following years were unusually quiet for intense storms landfalling in Florida, encouraging actions that further raised insurers’ hurricane risk costs. Among these was the 25 percent roof replacement rule in 2007, which mandated that if 25 percent or more of a roof is ‘repaired, replaced or recovered’ in any 12-month period, then the entire roofing system or roof section must be brought up to the latest building code. “Until the hurricanes returned with a vengeance in 2017,” says Peter Datin, senior director of modeling at RMS, “the significant additional cost imposed on insurers due to this code update was not clear.” Development of Hurricane Modeling Before Hurricane Andrew, exposure mapping by the insurance industry involved tracking premiums at a fairly coarse ‘Cresta Zone’ resolution. Post-Andrew, as modelers provided insurers with the ability to model exposures at a finer scale, insurers recognized how higher resolution data could provide a more accurate assessment of risk. RMS released its first hurricane model in 1993. Since then, there have been many updates and innovations, from basin-wide stochastic tracks, coupled ocean-atmosphere storm surge modeling, and significant enhancements in damage assessment modeling. After Hurricane Katrina in 2005, Robert Muir-Wood, chief research officer at RMS, coined the term ‘post-event loss amplification’ (PLA) to cover all processes that can raise losses after a major catastrophe, such as demand surge and claims inflation. Auguste Boissonnade, vice president of model development at RMS, who designed the first RMS hurricane model, worked on how to quantify these different factors in generating the overall insurance loss after cat events. Hurricane Katrina floodingFor the most extreme catastrophes, when damage requires the long-term evacuation of large parts of a city, the definition of a “super catastrophe” (or “super-cat”) event applies, where secondary consequences can be a significant component of the original damage. The flooding of New Orleans after Hurricane Katrina was such a super-cat. “With the hurricane catastrophes of 2004 and 2005 came the realization that cat loss models needed to allow for undervaluation of insured exposures as well as the secondary impact of economic, social, and political factors that could amplify the losses,” Boissonnade says. After major hurricanes, RMS vulnerability modelers review lessons that can be learned from the events and the resulting claims data. “Through claims analyses, it has been possible to quantify the degree to which changes in wind design codes have reduced damage and losses to buildings and incorporate those learnings into cat models,” added Datin. Current Market Dynamics The average cost of an annual homeowner’s policy in Florida is expected to soar to US$4,231 this year, almost three times the U.S. annual average, according to the Insurance Information Institute. Five Florida market insurers have already gone insolvent so far in 2022, faced with rising claims costs and increased costs for reinsurance. Meanwhile, the number of policies written by Citizens, a post-Andrew creation, has risen to over a million, as insurers have either gone insolvent, withdrawn capacity from the market, or had their ratings downgraded, making it harder for insureds to secure coverage that will meet their mortgage lenders’ approval. In July 2022, rating agency Demotech wrote to 17 insurers warning them they could be downgraded from A (exceptional) to S (substantial) or M (moderate), potentially impacting millions of policyholders whose mortgage providers demand home insurance from the strongest-rated carriers. Florida legislators then looked to circumvent the use of Demotech ratings with a new stopgap measure, where Citizens take on a reinsurance role to pay claims for insolvent insurers. At the same time, insurers are struggling to secure reinsurance capacity, and Citizens only managed to get a third of its desired reinsurance cover, making it harder for carriers to deploy sufficient capacity to meet the demand for hurricane coverage. There has also been a huge increase in the volume of catastrophe claims in recent years, driven by social inflation and undervaluation of exposures. Likely Impact of Andrew Now “Our prediction that a repeat of Andrew today could cause as much as US$100 billion in insured losses is based in large part on changes in exposure and population since 1992, coupled with updated predictions of the impact of wind and storm surge, with significant anticipated post-event loss amplification. Together these components reveal a more complete picture of potential economic and insured losses,” says Mohsen Rahnama, chief risk modeling officer at RMS. Combined wind and surge losses for a repeat of Hurricane Andrew are estimated at US$87 billion. Post-event loss amplification, whether it is from a slow recovery, supply chain issues from COVID-19, or current inflationary trends, could take the ultimate loss closer to US$100 billion. The impact of storm surge, particularly with the climate change-related rise in sea levels, is also more pronounced now compared to estimates at the time of Andrew. South Florida property developmentAdded to this is the significant demographic shift in Florida. As of this year, the population of Florida is estimated at over 22 million – a 61 percent increase from the number of people in 1992. Building counts in Andrew’s wind and surge footprints have increased by 40 percent to 1.9 million and by 32 percent to 55,000 respectively. Economic exposure has also increased by 77 percent in the wind footprint and 67 percent in the surge footprint. And in Miami-Dade County, the number of high-rise buildings that are over 15 stories has tripled since 1992, many of which are now potentially in Andrew’s surge footprint. “While the wind was the main driver of loss in 1992, the number of new, high-valued buildings near the coast suggests that storm surge losses may play an increasing role in a repeat of this event,” says Rahnama. In constant-dollar terms, economic exposure has grown substantially within both Andrew’s wind and surge footprints, based on an analysis of the total built floor area (see Figure 1). On top of this, cost inflation since 1992 has been substantial, with replacement costs in Florida estimated to have increased between two times and 2.5 times since 1992, based on historical construction cost indices. Figure 1: Exposure growth in Hurricane Andrew’s footprint (in constant dollars). Source: RMSOne key uncertainty in estimating the losses from a repeat of Hurricane Andrew concerns the impact of claims litigation. “Irma in 2017 was the first significant hurricane to make landfall since the 25 percent roof replacement rule was expanded in 2017 to all buildings across Florida, and it contributed to a significant increase in claims frequency and severity, as roof damage sustained during the storm attracted many roofing contractors, who handed over their exaggerated claims to be pursued by attorneys,” recalls Datin. An estimated US$15 billion has been paid to claimants by insurers in Florida since 2013, driven by assignment of benefits (AOB) cases, where litigation has capitalized on the 25 percent roof replacement rule, with a significant portion of the cost being driven by attorney’s fees on both sides. However, a new law passed by the Florida legislature in May 2022 changed the 25 percent roof replacement rule to exempt roofs “built, repaired, or replaced in compliance with the 2007 Florida Building Code, or any subsequent editions of the Florida Building Code.” “This means that only the damaged portion of the roof on newly built or upgraded roofs needs to be repaired after a damaging wind event instead of the entire roof or roofing system. Most importantly for insurers, the right of the contractor or assignee to obtain compensation for attorney fees – that drives up the cost of claims even further – has been removed,” adds Datin. Muir-Wood adds: “There is further hope for insurers following a recent appeal court ruling in Florida which could provide the blueprint for insurers to successfully argue against contractors in such lawsuits. Here we have at least one factor that is now being brought under control, which has significantly raised the insurance costs of hurricane losses. However, insurers will be watching closely to see if there is any reduction in social inflation because of recent legislative measures.” Can the US$100 Billion Repeat of Andrew be Prevented? Should another Category 5 hurricane make landfall in southeast Florida today, not only will the insured loss be more considerable, but the insurance industry will face major challenges that could severely impact its ability to withstand the event. What can the risk management industry do to mitigate losses? Risk modeling has advanced dramatically. “Insurers need to collect detailed data on their exposures and values and then employ high-resolution modeling alongside all those factors that can affect the ultimate loss, whether from post-event loss amplification or from more resilient construction standards,” says Muir-Wood. The spirit of the industry working together with regulators, similar to post-Andrew, needs to be resurrected. “To help insurance carriers to remain competitive, regulators and legislators have been working with the industry to prevent claims litigation from getting out of control and potentially threatening the viability of hurricane insurance in Florida,” adds Boissonnade. “And legislators also need to keep a close eye on how claims respond to the changes to the 25 percent roof replacement rule, and in measures that reduce the need for litigation, so as to reduce vexatious claims,” he adds. Datin acknowledges the role that risk modelers can play, “The catastrophe modeling community has already helped drive positive change in Florida by demonstrating the impacts of building codes and the effects of AOB-driven claims inflation on modeled risk.” In addition, says Rahnama: “It’s crucial that modeling for hurricane risk takes greater account of the effects of climate change on global warming and sea level rise, and the impact those will ultimately on wind and storm surge in the event of another hurricane like Andrew. Let’s not sleepwalk into another Andrew-type scenario. The insights are there, and the warning signs have flashed – we just need to learn from history.”
The Data Driving Wildfire Exposure Reduction
Recent research by RMS® in collaboration with the CIPR and IBHS is helping move the dial on wildfire risk assessment, providing a benefit-cost analysis of science-based mitigation strategies The significant increase in the impact of wildfire activity in North America in the last four years has sparked an evolving insurance problem. Across California, for example, 235,250 homeowners’ insurance policies faced non-renewal in 2019, an increase of 31 percent over the previous year. In addition, areas of moderate to very-high risk saw a 61 percent increase – narrow that to the top 10 counties and the non-renewal rate exceeded 200 percent. A consequence of this insurance availability and affordability emergency is that many residents have sought refuge in the California FAIR (Fair Access to Insurance Requirements) Plan, a statewide insurance pool that provides wildfire cover for dwellings and commercial properties. In recent years, the surge in wildfire events has driven a huge rise in people purchasing cover via the plan, with numbers more than doubling in highly exposed areas. In November 2020, in an effort to temporarily help the private insurance market and alleviate pressure on the FAIR Plan, California Insurance Commissioner Ricardo Lara took the extraordinary step of introducing a mandatory one-year moratorium on insurance companies non-renewing or canceling residential property insurance policies. The move was designed to help the 18 percent of California’s residential insurance market affected by the record 2020 wildfire season. The Challenge of Finding an Exit “The FAIR Plan was only ever designed as a temporary landing spot for those struggling to find fire-related insurance cover, with homeowners ultimately expected to shift back into the private market after a period of time,” explains Jeff Czajkowski, director of the Center for Insurance Policy and Research (CIPR) at the National Association of Insurance Commissioners. “The challenge that they have now, however, is that the lack of affordable cover means for many of those who enter the plan there is potentially no real exit strategy.” The FAIR Plan was only ever designed as a temporary landing spot for those struggling to find fire-related insurance cover, with homeowners ultimately expected to shift back into the private market after a period of time. The challenge that they have now, however, is that the lack of affordable cover means for many of those who enter the plan there is potentially no real exit strategy. Jeff Czajkowski, director of the Center for Insurance Policy and Research (CIPR) at the National Association of Insurance Commissioners These concerns are echoed by Matt Nielsen, senior director of global governmental and regulatory affairs at RMS. “Eventually you run into similar problems to those experienced in Florida when they sought to address the issue of hurricane cover. You simply end up with so many policies within the plan that you have to reassess the risk transfer mechanism itself and look at who is actually paying for it.” The most expedient way to develop an exit strategy is to reduce wildfire exposure levels, which in turn will stimulate activity in the private insurance market and lead to the improved availability and affordability of cover in exposed regions. Yet therein lies the challenge. There is a fundamental stumbling block to this endeavor unique to California’s insurance market and enshrined in regulation. California Code of Regulations, Article 4 – Determination of Reasonable Rates, §2644.5 – Catastrophe Adjustment: “In those insurance lines and coverages where catastrophes occur, the catastrophic losses of any one accident year in the recorded period are replaced by a loading based on a multi-year, long-term average of catastrophe claims. The number of years over which the average shall be calculated shall be at least 20 years for homeowners’ multiple peril fire. …” In effect, this regulation prevents the use of predictive modeling, the mainstay of exposure assessment and accurate insurance pricing, and limits the scope of applicable data to the last 20 years. That might be acceptable if wildfire constituted a relatively stable exposure and if all aspects of the risk could be effectively captured in a period of two decades – but as the last few years have demonstrated, that is clearly not the case. As Roy Wright, president and CEO of the Insurance Institute for Business & Home Safety (IBHS), states: “Simply looking back might be interesting, but is it relevant? I don’t mean that the data gathered over the last 20 years is irrelevant, but on its own it is insufficient to understand and get ahead of wildfire risk, particularly when you apply the last four years to the 20-year retrospective, which have significantly skewed the market. That is when catastrophe models provide the analytical means to rationalize such deviations and to anticipate how this threat might evolve.” Simply looking back might be interesting, but is it relevant? I don’t mean that the data gathered over the last 20 years is irrelevant, but on its own it is insufficient to understand and get ahead of wildfire risk, particularly when you apply the last four years to the 20-year retrospective, which have significantly skewed the market. Roy Wright, president and CEO, Insurance Institute for Business & Home Safety (IBHS) The insurance industry has long viewed wildfire as an attritional risk, but such a perspective is no longer valid, believes Michael Young, senior director of product management at RMS. “It is only in the last five years that we are starting to see wildfire damaging thousands of buildings in a single event,” he says. “We are reaching the level where the technology associated with cat modeling has become critical because without that analysis you can’t predict future trends. The significant increase in related losses means that it has the potential to be a solvency-impacting peril as well as a rate-impacting one.” Addressing the Insurance Equation “Wildfire by its nature is a hyper-localized peril, which makes accurate assessment very data dependent,” Young continues. “Yet historically, insurers have relied upon wildfire risk scores to guide renewal decisions or to write new business in the wildland-urban interface (WUI). Such approaches often rely on zip-code-level data, which does not factor in environmental, community or structure-level mitigation measures. That lack of ground-level data to inform underwriting decisions means, often, non-renewal is the only feasible approach in highly exposed areas for insurers.” California is unique as it is the only U.S. state to stipulate that predictive modeling cannot be applied to insurance rate adjustments. However, this limitation is currently coming under significant scrutiny from all angles. In recent months, the California Department of Insurance has convened two separate investigatory hearings to address areas including: Insurance availability and affordability Need for consistent home-hardening standards and insurance incentives for mitigation Lack of transparency from insurers on wildfire risk scores and rate justification In support of efforts to demonstrate the need for a more data-driven, model-based approach to stimulating a healthy private insurance market, the CIPR, in conjunction with IBHS and RMS, has worked to facilitate greater collaboration between regulators, the scientific community and risk modelers in an effort to raise awareness of the value that catastrophe models can bring. “The Department of Insurance and all other stakeholders recognize that until we can create a well-functioning insurance market for wildfire risk, there will be no winners,” says Czajkowski. “That is why we are working as a conduit to bring all parties to the table to facilitate productive dialogue. A key part of this process is raising awareness on the part of the regulator both around the methodology and depth of science and data that underpins the cat model outputs.” In November 2020, as part of this process, CIPR, RMS and IBHS co-produced a report entitled “Application of Wildfire Mitigation to Insured Property Exposure.” “The aim of the report is to demonstrate the ability of cat models to reflect structure-specific and community-level mitigation measures,” Czajkowski continues, “based on the mitigation recommendations of IBHS and the National Fire Protection Association’s Firewise USA recognition program. It details the model outputs showing the benefits of these mitigation activities for multiple locations across California, Oregon and Colorado. Based on that data, we also produced a basic benefit-cost analysis of these measures to illustrate the potential economic viability of home-hardening measures.” Applying the Hard Science The study aims to demonstrate that learnings from building science research can be reflected in a catastrophe model framework and proactively inform decision-making around the reduction of wildfire risk for residential homeowners in wildfire zones. As Wright explains, the hard science that IBHS has developed around wildfire is critical to any model-based mitigation drive. “For any model to be successful, it needs to be based on the physical science. In the case of wildfire, for example, our research has shown that flame-driven ignitions account for approximately only a small portion of losses, while the vast majority are ember-driven. “Our facilities at IBHS enable us to conduct full-scale testing using single- and multi-story buildings, assessing components that influence exposure such as roofing materials, vents, decks and fences, so we can generate hard data on the various impacts of flame, ember, smoke and radiant heat. We can provide the physical science that is needed to analyze secondary and tertiary modifiers—factors that drive so much of the output generated by the models.” Our facilities at IBHS enable us to conduct full-scale testing using single- and multi-story buildings, assessing components that influence exposure such as roofing materials, vents, decks and fences, so we can generate hard data on the various impacts of flame, ember, smoke and radiant heat. Roy Wright, president and CEO, Insurance Institute for Business & Home Safety (IBHS) To quantify the benefits of various mitigation features, the report used the RMS® U.S. Wildfire HD Model to quantify hypothetical loss reduction benefits in nine communities across California, Colorado and Oregon. The simulated reductions in losses were compared to the costs associated with the mitigation measures, while a benefit-cost methodology was applied to assess the economic effectiveness of the two overall mitigation strategies modeled: structural mitigation and vegetation management. The multitude of factors that influence the survivability of a structure exposed to wildfire, including the site hazard parameters and structural characteristics of the property, were assessed in the model for 1,161 locations across the communities, three in each state. Each structure was assigned a set of primary characteristics based on a series of assumptions. For each property, RMS performed five separate mitigation case runs of the model, adjusting the vulnerability curves based on specific site hazard and secondary modifier model selections. This produced a neutral setting with all secondary modifiers set to zero—no penalty or credit applied—plus two structural mitigation scenarios and two vegetation management scenarios combined with the structural mitigation. The Direct Value of Mitigation Given the scale of the report, although relatively small in terms of the overall scope of wildfire losses, it is only possible to provide a snapshot of some of the key findings. The full report is available to download. Focusing on the three communities in California—Upper Deerwood (high risk), Berry Creek (high risk) and Oroville (medium risk)—the neutral setting produced an average annual loss (AAL) per structure of $3,169, $637 and $35, respectively. Figure 1: Financial impact of adjusting the secondary modifiers to produce both a structural (STR) credit and penaltyFigure 1 shows the impact of adjusting the secondary modifiers to produce a structural (STR) maximum credit (i.e., a well-built, wildfire-resistant structure) and a structural maximum penalty (i.e., a poorly built structure with limited resistance). In the case of Upper Deerwood, the applied credit saw an average reduction of $899 (i.e., wildfire-avoided losses) compared to the neutral setting, while conversely the penalty increased the AAL on average $2,409. For Berry Creek, the figures were a reduction of $222 and an increase of $633. And for Oroville, which had a relatively low neutral setting, the average reduction was $26. Figure 2: Financial analysis of the mean AAL difference for structural (STR) and vegetation (VEG) credit and penalty scenariosIn Figure 2 above, analyzing the mean AAL difference for structural and vegetation (VEG) credit and penalty scenarios revealed a reduction of $2,018 in Upper Deerwood and an increase of $2,511. The data, therefore, showed that moving from a poorly built to well-built structure on average reduced wildfire expected losses by $4,529. For Berry Creek, this shift resulted in an average savings of $1,092, while for Oroville there was no meaningful difference. The authors then applied three cost scenarios based on a range of wildfire mitigation costs: low ($20,000 structural, $25,000 structural and vegetation); medium ($40,000 structural, $50,000 structural and vegetation); and high ($60,000 structural, $75,000 structural and vegetation). Focusing again on the findings for California, the model outputs showed that in the low-cost scenario (and 1 percent discount rate) for 10-, 25- and 50-year time horizons, both structural only as well as structural and vegetation wildfire mitigation were economically efficient on average in the Upper Deerwood, California, community. For Berry Creek, California, economic efficiency for structural mitigation was achieved on average in the 50-year time horizon and in the 25- and 50-year time horizons for structural and vegetation mitigation. Moving the Needle Forward As Young recognizes, the scope of the report is insufficient to provide the depth of data necessary to drive a market shift, but it is valuable in the context of ongoing dialogue. “This report is essentially a teaser to show that based on modeled data, the potential exists to reduce wildfire risk by adopting mitigation strategies in a way that is economically viable for all parties,” he says. “The key aspect about introducing mitigation appropriately in the context of insurance is to allow the right differential of rate. It is to give the right signals without allowing that differential to restrict the availability of insurance by pricing people out of the market.” That ability to differentiate at the localized level will be critical to ending what he describes as the “peanut butter” approach—spreading the risk—and reducing the need to adopt a non-renewal strategy for highly exposed areas. “You have to be able to operate at a much more granular level,” he explains, “both spatially and in terms of the attributes of the structure, given the hyperlocalized nature of the wildfire peril. Risk-based pricing at the individual location level will see a shift away from the peanut-butter approach and reduce the need for widespread non-renewals. You need to be able to factor in not only the physical attributes, but also the actions by the homeowner to reduce their risk. Risk-based pricing at the individual location level will see a shift away from the peanut-butter approach and reduce the need for widespread non-renewals. You need to be able to factor in not only the physical attributes, but also the actions by the homeowner to reduce their risk. Michael Young, senior director of product management at RMS “It is imperative we create an environment in which mitigation measures are acknowledged, that the right incentives are applied and that credit is given for steps taken by the property owner and the community. But to reach that point, you must start with the modeled output. Without that analysis based on detailed, scientific data to guide the decision-making process, it will be incredibly difficult for the market to move forward.” As Czajkowski concludes: “There is no doubt that more research is absolutely needed at a more granular level across a wider playing field to fully demonstrate the value of these risk mitigation measures. However, what this report does is provide a solid foundation upon which to stimulate further dialogue and provide the momentum for the continuation of the critical data-driven work that is required to help reduce exposure to wildfire.”
Data From the Ashes
Five years on from the wildfire that devastated Fort McMurray, the event has proved critical to developing a much deeper understanding of wildfire losses in Canada In May 2016, Fort McMurray, Alberta, became the location of Canada’s costliest wildfire event to date. In total, some 2,400 structures were destroyed by the fire, with a similar number designated as uninhabitable. Fortunately, the evacuation of the 90,000-strong population meant that no lives were lost as a direct result of the fires. From an insurance perspective, the estimated CA$4 billion loss elevated wildfire risk to a whole new level. This was a figure now comparable to the extreme fire losses experienced in wildfire-exposed regions such as California, and established wildfire as a peak natural peril second only to flood in Canada. However, the event also exposed gaps in the market’s understanding of wildfire events and highlighted the lack of actionable exposure data. In the U.S., significant investment had been made in enhancing the scale and granularity of publicly available wildfire data through bodies such as the United States Geological Survey, but the resolution of data available through equivalent parties in Canada was not at the same standard. A Question of Scale Making direct wildfire comparisons between the U.S. and Canada is difficult for multiple reasons. Take, for example, population density. Canada’s total population is approximately 37.6 million, spread over a landmass of 9,985 million square kilometers (3,855 million square miles), while California has a population of around 39.5 million, inhabiting an area of 423,970 square kilometers (163,668 square miles). The potential for wildfire events impacting populated areas is therefore significantly less in Canada. In fact, in the event of a wildfire in Canada—due to the reduced potential exposure—fires are typically allowed to burn for longer and over a wider area, whereas in the U.S. there is a significant focus on fire suppression. This willingness to let fires burn has the benefit of reducing levels of vegetation and fuel buildup. Also, more fires in the country are a result of natural rather than human-caused ignitions and occur in hard-to-access areas with low population exposure. Sixty percent of fires in Canada are attributed to human causes. The challenge for the insurance industry in Canada is therefore more about measuring the potential impact of wildfire on smaller pockets of exposure Michael Young, senior director, product management, at RMS But as Fort McMurray showed, the potential for disaster clearly exists. In fact, the event was one of a series of large-scale fires in recent years that have impacted populated areas in Canada, including the Okanagan Mountain Fire, the McLure Fire, the Slave Lake Fire, and the Williams Lake and Elephant Hills Fire. “The challenge for the insurance industry in Canada,” explains Michael Young, senior director, product management, at RMS, “is therefore more about measuring the potential impact of wildfire on smaller pockets of exposure, rather than the same issues of frequency and severity of event that are prevalent in the U.S.” Regions at Risk What is interesting to note is just how much of the populated territories are potentially exposed to wildfire events in Canada, despite a relatively low population density overall. A 2017 report entitled Mapping Canadian Wildland Fire Interface Areas, published by the Canadian Forest Service, stated that the threat of wildfire impacting populated areas will inevitably increase as a result of the combined impacts of climate change and the development of more interface area “due to changes in human land use.” This includes urban and rural growth, the establishment of new industrial facilities and the building of more second homes. According to the study, the wildland-human interface in Canada spans 116.5 million hectares (288 million acres), which is 13.8 percent of the country’s total land area or 20.7 percent of its total wildland fuel area. In terms of the wildland-urban interface (WUI), this covers 32.3 million hectares (79.8 million acres), which is 3.8 percent of land area or 5.8 percent of fuel area. The WUI for industrial areas (known as WUI-Ind) covers 10.5 million hectares (25.9 million acres), which is 1.3 percent of land area or 1.9 percent of fuel area. In terms of the provinces and territories with the largest interface areas, the report highlighted Quebec, Alberta, Ontario and British Columbia as being most exposed. At a more granular level, it stated that in populated areas such as cities, towns and settlements, 96 percent of locations had “at least some WUI within a five-kilometer buffer,” while 60 percent also had over 500 hectares (1,200 acres) of WUI within a five-kilometer buffer (327 of the total 544 areas). Data: A Closer Look Fort McMurray has, in some ways, become an epicenter for the generation of wildfire-related data in Canada. According to a study by the Institute for Catastrophic Loss Reduction, which looked at why certain homes survived, the Fort McMurray Wildfire “followed a well-recognized pattern known as the wildland/urban interface disaster sequence.” The detailed study, which was conducted in the aftermath of the disaster, showed that 90 percent of properties in the areas affected by the wildfire survived the event. Further, “surviving homes were generally rated with ‘Low’ to ‘Moderate’ hazard levels and exhibited many of the attributes promoted by recommended FireSmart Canada guidelines.” FireSmart Canada is an organization designed to promote greater wildfire resilience across the country. Similar to FireWise in the U.S., it has created a series of hazard factors spanning aspects such as building structure, vegetation/fuel, topography and ignition sites. It also offers a hazard assessment system that considers hazard layers and adoption rates of resilience measures. According to the study: “Tabulation by hazard level shows that 94 percent of paired comparisons of all urban and country residential situations rated as having either ‘Low’ or ‘Moderate’ hazard levels survived the wildfire. Collectively, vegetation/fuel conditions accounted for 49 percent of the total hazard rating at homes that survived and 62 percent of total hazard at homes that failed to survive.” Accessing the Data In many ways, the findings of the Fort McMurray study are reassuring, as they clearly demonstrate the positive impact of structural and topographical risk mitigation measures in enhancing wildfire resilience—essentially proving the underlying scientific data. Further, the data shows that “a strong, positive correlation exists between home destruction during wildfire events and untreated vegetation within 30 meters of homes.” “What the level of survivability in Fort McMurray showed was just how important structural hardening is,” Young explains. “It is not simply about defensible space, managing vegetation and ensuring sufficient distance from the WUI. These are clearly critical components of wildfire resilience, but by factoring in structural mitigation measures you greatly increase levels of survivability, even during urban conflagration events as extreme as Fort McMurray.” What the level of survivability in Fort McMurray showed was just how important structural hardening is Michael Young, senior director, product management, RMS From an insurance perspective, access to these combined datasets is vital to effective exposure analysis and portfolio management. There is a concerted drive on the part of the Canadian insurance industry to adopt a more data-intensive approach to managing wildfire exposure. Enhancing data availability across the region has been a key focus at RMS® in recent years, and efforts have culminated in the launch of the RMS® Canada Wildfire HD Model. It offers the most complete view of the country’s wildfire risk currently available and is the only probabilistic model available to the market that covers all 10 provinces. “The hazard framework that the model is built on spans all of the critical wildfire components, including landscape and fire behavior patterns, fire weather simulations, fire and smoke spread, urban conflagration and ember intensity,” says Young. “In each instance, the hazard component has been precisely calibrated to reflect the dynamics, assumptions and practices that are specific to Canada. “For example, the model’s fire spread component has been adjusted to reflect the fact that fires tend to burn for longer and over a wider area in the country, which reflects the watching brief that is often applied to managing wildfire events, as opposed to the more suppression-focused approach in the U.S.,” he continues. “Also, the urban conflagration component helps insurers address the issue of extreme tail-risk events such as Fort McMurray.” Another key model differentiator is the wildfire vulnerability function, which automatically determines key risk parameters based on high-resolution data. In fact, RMS has put considerable efforts into building out the underlying datasets by blending multiple different information sources to generate fire, smoke and ember footprints at 50-meter resolution, as opposed to the standard 250-meter resolution of the publicly available data. Critical site hazard data such as slope, distance to vegetation, and fuel types can be set against primary building modifiers such as construction, number of stories and year built. A further secondary modifier layer enables insurers to apply building-specific mitigation measures such as roof characteristics, ember accumulators and whether the property has cladding or a deck. Given the influence of such components on building survivability during the Fort McMurray Fire, such data is vital to exposure analysis at the local level. A Changing Market “The market has long recognized that greater data resolution is vital to adopting a more sophisticated approach to wildfire risk,” Young says. “As we worked to develop this new model, it was clear from our discussions with clients that there was an unmet need to have access to hard data that they could ‘hang numbers from.’ There was simply too little data to enable insurers to address issues such as potential return periods, accumulation risk and countrywide portfolio management.” The ability to access more granular data might also be well timed in response to a growing shift in the information required during the insurance process. There is a concerted effort taking place across the Canadian insurance market to reduce the information burden on policyholders during the submission process. At the same time, there is a shift toward risk-based pricing. “As we see this dynamic evolve,” Young says, “the reduced amount of risk information sourced from the insured will place greater importance on the need to apply modeled data to how insurance companies manage and price risk accurately. Companies are also increasingly looking at the potential to adopt risk-based pricing, a process that is dependent on the ability to apply exposure analysis at the individual location level. So, it is clear from the coming together of these multiple market shifts that access to granular data is more important to the Canadian wildfire market than ever.”
Climate Change: The Cost of Inaction
With pressure from multiple directions for a change in the approach to climate risk, how the insurance industry responds is under scrutiny Severe threats to the climate account for all of the top long-term risks in this year’s World Economic Forum (WEF) “Global Risks Report.” For the first time in the survey’s 10-year outlook, the top five global risks in terms of likelihood are all environmental. From an industry perspective, each one of these risks has potentially significant consequences for insurance and reinsurance companies: Extreme weather events with major damage to property, infrastructure and loss of human life Failure of climate change mitigation and adaptation by governments and businesses Man-made environmental damage and disasters including massive oil spills and incidents of radioactive contamination Major biodiversity loss and ecosystem collapse (terrestrial or marine) with irreversible consequences for the environment, resulting in severely depleted resources for humans as well as industries Major natural disasters such as earthquakes, tsunamis, volcanic eruptions and geomagnetic storms “There is mounting pressure on companies from investors, regulators, customers and employees to demonstrate their resilience to rising climate volatility,” says John Drzik, chairman of Marsh and McLennan Insights. “Scientific advances mean that climate risks can now be modeled with greater accuracy and incorporated into risk management and business plans. High-profile events, like recent wildfires in Australia and California, are adding pressure on companies to take action on climate risk.” There is mounting pressure on companies from investors, regulators, customers and employees to demonstrate their resilience to rising climate volatility” John Drzik Marsh and McLennan Insights In December 2019, the Bank of England introduced new measures for insurers, expecting them to assess, manage and report on the financial risks of climate change as part of the bank’s 2021 Biennial Exploratory Scenario (BES) exercise. The BES builds on the Prudential Regulatory Authority’s Insurance Stress Test 2019, which asked insurers to stress test their assets and liabilities based on a series of future climate scenarios. The Network for the Greening of the Financial System shows how regulators in other countries are moving in a similar direction. “The BES is a pioneering exercise, which builds on the considerable progress in addressing climate-related risks that has already been made by firms, central banks and regulators,” said outgoing Bank of England governor Mark Carney. “Climate change will affect the value of virtually every financial asset; the BES will help ensure the core of our financial system is resilient to those changes.” The insurance industry’s approach to climate change is evolving. Industry-backed groups such as ClimateWise have been set up to respond to the challenges posed by climate change while also influencing policymakers. “Given the continual growth in exposure to natural catastrophes, insurance can no longer simply rely on a strategy of assessing and re-pricing risk,” says Maurice Tulloch, former chair of ClimateWise and CEO of international insurance at Aviva. “Doing so threatens a rise of uninsurable markets.” The Cost of Extreme Events In the past, property catastrophe (re)insurers were able to recalibrate their perception of natural catastrophe risk on an annual basis, as policies came up for renewal, believing that changes to hazard frequency and/or severity would occur incrementally over time. However, it has become apparent that some natural hazards have a much greater climate footprint than had been previously imagined. Attribution studies are helping insurers and other stakeholders to measure the financial impact of climate change on a specific event. “You have had events in the last few years that have a climate change signature to them,” says Robert Muir-Wood, chief research officer of science and technology at RMS. “That could include wildfire in California or extraordinary amounts of rainfall during Hurricane Harvey over Houston, or the intensity of hurricanes in the Caribbean, such as Irma, Maria and Dorian. “These events appear to be more intense and severe than those that have occurred in the past,” he continues. “Attribution studies are corroborating the fact that these natural disasters really do have a climate change signature. It was a bit experimental to start with, but now it’s just become a regular part of the picture, that after every event a designated attribution study program will be undertaken … often by more than one climate lab. “In the past it was a rather futile argument whether or not an event had a greater impact because of climate change, because you couldn’t really prove the point,” he adds. “Now it’s possible to say not only if an event has a climate change influence, but by how much. The issue isn’t whether something was or was not climate change, it’s that climate change has affected the probability of an event like that by this amount. That is the nature of the conversation now, which is an intelligent way of thinking about it.” Now it’s possible to say not only if an event has a climate change influence, but by how much. The issue isn’t whether something was or was not climate change, it’s that climate change has affected the probability of an event like that by this amount Robert Muir-Wood RMS Record catastrophe losses in 2017 and 2018 — with combined claims costing insurers US$230 billion, according to Swiss Re sigma — have had a significant impact on the competitive and financial position of many property catastrophe (re)insurers. The loss tally from 2019 was less severe, with global insurance losses below the 10-year average at US$56 billion, but Typhoons Faxai and Hagibis caused significant damage to Japan when they occurred just weeks apart in September and October. “It can be argued that the insurance industry is the only sector that is going to be able to absorb the losses from climate change,” adds Muir-Wood. “Companies already feel they are picking up losses in this area and it’s a bit uncharted — you can’t just use the average of history. It doesn’t really work anymore. So, we need to provide the models that give our clients the comfort of knowing how to handle and price climate change risks in anticipation.” The Cost of Short-Termism While climate change is clearly on the agenda of the boards of international insurance and reinsurance firms, its emphasis differs from company to company, according to the Geneva Association. In a report, the industry think tank found that insurers are hindered from scaling up their contribution to climate adaptation and mitigation by barriers that are imposed at a public policy and regulatory level. The need to take a long-term view on climate change is at odds with the pressures that insurance companies are under as public and regulated entities. Shareholder expectations and the political demands to keep insurance rates affordable are in conflict with the need to charge a risk-adjusted price or reduce exposures in regions that are highly catastrophe exposed. Examples of this need to protect property owners from full risk pricing became an election issue in the Florida market when state-owned carrier Florida Citizens supported customers with effectively subsidized premiums. The disproportionate emphasis on using the historical record as a means of modeling the probability of future losses is a further challenge for the private market operating in the state. “In the past when insurers were confronted with climate change, they were comfortable with the sense that they could always put up the price or avoid writing the business if the risk got too high,” says Muir-Wood. “But I don’t think that’s a credible position anymore. We see situations, such as in California, where insurers are told they should already have priced in climate change risk and they need to use the average of the last 30 years, and that’s obviously a challenge for the solvency of insurers. Regulators want to be up to speed on this. If levels of risk are increasing, they need to make sure that (re)insurance companies can remain solvent. That they have enough capital to take on those risks. “The Florida Insurance Commissioner’s function is more weighted to look after the interests of consumers around insurance prices, and they maintain a very strong line that risk models should be calibrated against the long-term historical averages,” he continues. “And they’ve said that both in Florida for hurricane and in California for wildfire. And in a time of change and a time of increased risk, that position is clearly not in the interest of insurers, and they need to be thinking carefully about that. “Regulators want to be up to speed on this,” he adds. “If levels of risk are increasing, they need to make sure that (re)insurance companies can remain solvent. That they have enough capital to take on those risks. And supervisors will expect the companies they regulate to turn up with extremely good arguments and a demonstration of the data behind their position as to how they are pricing their risk and managing their portfolios.” The Reputational Cost of Inaction Despite the persistence of near-term pressures, a lack of action and a long-term view on climate change is no longer a viable option for the industry. In part, this is due to a mounting reputational cost. European and Australian (re)insurers have, for instance, been more proactive in divesting from fossil fuels than their American and Asian counterparts. This is expected to change as negative attention mounts in both mainstream and social media. The industry’s retreat from coal is gathering pace as public pressure on the fossil fuel industry and its supporters grows. The number of insurers withdrawing cover for coal more than doubled in 2019, with coal exit policies announced by 17 (re)insurance companies. “The role of insurers is to manage society’s risks — it is their duty and in their own interest to help avoid climate breakdown,” says Peter Bosshard, coordinator of the Unfriend Coal campaign. “The industry’s retreat from coal is gathering pace as public pressure on the fossil fuel industry and its supporters grows.” The influence of climate change activists such as Greta Thunberg, the actions of NGO pressure groups like Unfriend Coal and growing climate change disclosure requirements are building a critical momentum and scrutiny into the action (or lack thereof) taken by insurance senior management. “If you are in the driver’s seat of an insurance company and you know your customers’ attitudes are shifting quite fast, then you need to avoid looking as though you are behind the curve,” says Muir-Wood. “Quite clearly there is a reputational side to this. Attitudes are changing, and as an industry we should anticipate that all sorts of things that are tolerated today will become unacceptable in the future.” To understand your organization’s potential exposure to climate change contact the RMS team here