There’s a lot to learn from the U.S.’s costliest year of weather catastrophes.

The year 2017 was the most costly year on record from natural catastrophes in the United States and its territory of Puerto Rico — ever. Major catastrophic events — Hurricanes Harvey, Irma and Maria, and last fall’s combined California wildfires — notably broke their own records as well.

Shifting weather patterns will likely play a role in future loss severities, with the potential of stronger hurricanes and additional drought-fueled western wildfires causing larger losses. Socioeconomic shifts in the United States also increase the potential for more damaging future cats.¹

Other perils can cause cat events. From a geophysical perspective, the chance of earthquakes continually looms large. The Kilauea volcanic eruptions on Hawaii’s Big Island and the ensuing major earthquakes demonstrate Mother Nature’s worst. It also shows that people are willing to live in extremely vulnerable areas partly because they believe “the government will bail them out,” observes Robert Hartwig, director of the University of South Carolina’s Center for Risk and Uncertainty Management. “Kilauea is a recent illustration of how humans are creating and exacerbating the tragedy of loss and damage from natural catastrophes,” he adds.

Besides costing lives and causing a historic financial loss, last year’s major cats also allow the insurance industry to gauge its progress on loss prevention efforts and its ability to handle large cat events. While the insurance industry’s claim paying resources have grown substantially since 2005 — the most expensive cat year for insurance losses on record largely from hurricanes Katrina, Rita and Wilma — significant vulnerabilities from natural perils and large uninsured and underinsured populations.

The Financials

The economic cost of last year’s four major cats and 12 other weather and climate disasters in the U.S. was $306 billion,² according to National Oceanic and Atmospheric Administration (NOAA) estimates, which include insurer losses. “Last year will go down as the second costliest year for U.S. insurers of all time,” says Don Griffin, vice president of personal lines for the Property Casualty Insurers Association of America (PCI). “At this point, more than 95 percent of the claims from the wildfires and hurricanes have been settled,” he explains.

Last year’s major catastrophes showcase the insurance industry’s financial vitality. “The industry was able to internalize the losses and manage them financially and logically in a way that, quite frankly, should be the envy of every industry,” Hartwig says. If similar circumstances happened to any other industry, he adds, it would lead to a plunge in the stock market.

However, 2017’s major cats also left imprints, including profitability declines, according to industry reports. For U.S. P&C insurers and reinsurers, the 2017 combined ratio rose to 103.8 percent, a three point deterioration from 2016, according to “First Look — 2017 Property/Casualty Financial Results,” released in March. Cat losses account for 10 points of the combined ratio, according to the report, which is based on data from carriers representing 96 percent of total industry net written premiums and 94 percent of total policyholder surplus.

Fitch Ratings’ look at GAAP 2017 year-end results for 51 North American P&C insurers and reinsurers concludes that the combined ratio rose to 102 percent in 2017, up from 96.8 percent in 2016, according to its report, “North American Property/Casualty Insurers’ 2017 Results.” Cat losses rose to $33.7 billion, or 9.5 percent of earned premiums, up from $12.9 billion, or 3.9 percent in 2016, the March report states.

In a joint release in May,³ Insurance Services Office (ISO) and PCI estimate that P&C carriers’ 2017 net income declined nearly 16 percent to $36 billion compared to 2016. Meanwhile, underwriting losses substantially rose to $23.33 billion in 2017, up from $4.71 billion the prior year, notes the ISO and PCI.

Investment earnings did cushion the blow. Insurer and reinsurance surplus grew 6.8 percent to $733.8 billion in 2017, propelled by a $39.4 billion rise in unrealized capital gains, according to A.M. Best. This was offset by a $17.5 billion decline in other surplus gains and a $4.4 billion increase in stockholder dividends. “Insurers, it seems, were fortunate in that what Mother Nature taketh away, Wall Street returneth,” Hartwig says.

Experiences of State Farm Insurance and Liberty Mutual Insurance Company — two of the nation’s top 10 largest personal lines insurance companies — provide glimpses into the financial impact of cat losses on insurers.

State Farm Group, the largest U.S. personal lines insurer, reports a pre-tax operating loss of $1.7 billion due to a combined underwriting loss of $6.5 billion in 2017 caused by “significant catastrophe losses.” Meanwhile, the group’s net worth grew to $97 billion, primarily due to an increase in the value of its unaffiliated stock portfolio.

Boston-based Liberty Mutual Holding Company saw net income drop significantly from $1 billion in 2016 to $17 million for 2017 partially due to the cats. When claims from the hurricane trio arrived during the third quarter, the insurer’s combined ratio climbed to 116.2 percent.⁴ However, the total 2017 combined ratio settled at 105.6 percent, a 7.3 point increase from 2016.

Due to the cause of damage and participation in insurance coverage, each major cat hit specific lines differently. Harvey especially affected the National Flood Insurance Program (NFIP) and private auto insurers. Because of the lack of personal lines coverage, commercial insurance bore most of Hurricane Maria’s insured losses in Puerto Rico. Homeowners’ insurers and ceded reinsurance partners covered California’s wildfires.

Irma greatly affected the Florida residential property market with sizable recoverables from the reinsurance market, according to Fitch’s report. Specifically, in 2017 the reinsurance and Florida specialist subsegments saw cat losses, as expressed in terms of earned premium, rise 24 percent and 11.6 percent, respectively.

For the NFIP, 2017 was the second worst loss year at $9.335 billion for the hurricane trio alone.⁵ NFIP’s first reinsurance purchase last year was a great call, as the nation’s public flood insurer recovered $1.042 billion to pay losses.⁶ For 2018 the NFIP raised rates by 8 percent,⁷ bought $1.46 billion in reinsurance⁸ and, for the first time, plans to transfer additional risk through insurance-linked securities on or about July 1, 2018.⁹ Due to last year’s rise of flood claims, insurer interest in selling private residential flood coverage has slowed down a bit, Griffin observes.

U.S. cat losses comprised the largest cost to reinsurers around the globe. For Swiss Re Group, as an example, aggregate fiscal year net income dropped 91 percent to $331 million, down from $3.56 billion in 2016, partially due to U.S. cats.¹⁰  The group’s combined ratio rose to 111.5 percent, up from 93.5 in 2016.

NFIP’s first reinsurance purchase last year was a great call, as the nation’s public flood insurer recovered $1.042 billion to pay losses.

Lloyds of London, a major flood insurance backer in the United States, posted a pretax loss of 2.3 billion euros ($2.7 billion) as of December 31, 2017 compared to a pre-tax profit of 2.5 billion euros ($2.6 billion) in 2016. Its combined ratio deteriorated from 98 percent in 2016 to 114 percent in 2017. ¹¹ Lloyds anticipates $4.8 billion in losses from hurricanes Harvey, Irma and Maria, the Miami Herald reports.¹²

And yet, despite the losses, rates are stable overall. “The record catastrophe losses of 2017 are having a remarkably muted effect on P&C insurance markets in the United States,” Hartwig observes. Pricing for homeowners insurance continues to move gradually upward. Commercial property and business interruption coverage prices, which had been declining, are now flat to up slightly, though increases are larger in catastrophe-impacted areas, Hartwig adds.

“Commercial and personal auto lines continue to see the most robust and sustained rate gains of all major P&C lines, but these trends are driven primarily by rising non-cat claim severities,” he explains. For reinsurers, he says, last year’s high cat losses “arrested a multi-year slide in property-catastrophe reinsurance pricing, with 2018 rates flattening or even rising slightly for some categories of risk.”

Strengths and Opportunities

Last year’s cats reveal both the strength of the insurance industry and room for adjustment. For starters, cat modeling has come a long way and continues to evolve. While most insurers and reinsurers are using hurricane cat models that combine only wind and storm surge, new models are becoming available that include flood risk, says Dag Lohmann, CEO of KatRisk, a catastrophe modeling company. He expects greater adoption of these models, including his company’s, by the 2019 hurricane season.

New models for the wildfires in the U.S. and Canada are also becoming available, he says. “The whole industry is waking up to the fact that we need to better embed correlation of perils (among) regions or continents into these models,” observes Lohmann. For example, wildfire models should reflect the anti-correlation with floods. “Before, we were not able to quantify the interconnectedness and didn’t have the tools to make informed decisions,” he explains.

The insurance industry is driving cat modeling because weather and climate models do not inform insurer portfolios, he notes. “The link between climate models and cat models is not as well established as it should be,” he says. “Machine learning and artificial intelligence will play a prominent role in making that connection in the future.”

Strong Building Codes and Materials Work

The strength of building codes and compliance, as well as the use of the appropriate building materials, are critical for reducing risk potential. “Irma showed us that the strict building codes of Florida are doing their job,” observes Mark Bove, senior research meteorologist at Munich Reinsurance America, Inc. “It is a success story that really needs to be amplified.”

Adhering to the Federal Emergency Management Administration (FEMA) standards makes big differences as well. In Texas, buildings elevated to current FEMA standards suffered much less damage than those built before FEMA’s flood maps, which were grandfathered with previous code standards, according to Aon Benfield’s report, “Hurricane Harvey: Event Recap.”

Elevating buildings to FEMA standards can be expensive and easily reaches six figures per structure. One contractor estimates elevation costs at $75 per square foot.¹³ Some residents are paying the tab, sometimes with help from FEMA, while others have to move. However, presuming flood-risk potential with FEMA maps can give people a false sense of security, Bove warns. “In reality, everyone has a flood risk,” he says. A Rice University/Kinder Institute study supports that view, concluding that 41 percent of likely flooded homes during Harvey were outside of the NFIP’s special flood hazard areas.¹⁴

Coastal Texas will become more vulnerable to flooding as time passes. In some areas within Houston, the ground is sinking by up to 6 cm or 2.36 inches annually, and building on alluvial soil, groundwater abstraction and rivers with low discharge capacity will also exacerbate flood risk in the region, according to Munich Re’s report, “Hurricane Harvey: Record-breaking floods inundate Houston.”¹⁵ Since Harvey, the Houston area is shelving work on libraries, street replacements, utility infrastructure and more in order to address reconstruction and mitigation.

In Puerto Rico, residential homes built to proper code experienced minimal damage, according to “Hurricane Maria: Recap Report,” issued in March 2018 by Aon Benfield. But a significant portion of residential property, which was illegally built with wood-frame construction or additions, suffered extensive or total damage.

Building materials also matter. In Puerto Rico, the best-built homes are of concrete construction with a bunker-style frame, the report notes. In Florida, metal roofs performed the best and ceramic and clay tile generally did well, according to Aon Benfield’s report, “Hurricane Irma: Event Recap,” published in March. However, standard shingle roofs struggled with winds exceeding 100 mph.¹⁶

Small businesses also need a nudge. Where cat events hit last year, 40 percent of 1,800 small businesses with 500 or fewer employees lost revenue and experienced uninsured damages.

Protecting buildings from wildfire damage means using noncombustible construction materials such as asphalt shingles and masonry or stucco cladding, Bove says. Landowners should avoid planting trees and shrubs immediately around structures, he advises. Bove believes that wildfire risk should be a community commitment to remove potential kindling from yards, roofs and gutters, especially in urban areas.

More Coverage Needed

While amplifying risk awareness and prevention is critical, lack of sufficient insurance coverage hampers recovery. California residents and businesses were generally well-covered against wildfire losses. However, the majority of residents in Puerto Rico, as well as high percentages of those in cat-affected areas in Texas, Florida, Georgia and South Carolina, lacked sufficient flood insurance.

Small businesses also need a nudge. Where cat events hit last year, 40 percent of 1,800 small businesses with 500 or fewer employees lost revenue and experienced uninsured damages, according to a Federal Reserve Bank survey released in April. Of those, 61 percent lost up to $25,000 in revenue and 35 percent lost more than $25,000, while only 4 percent reported no losses, notes the report, “Small Business Credit Survey: Report on Disaster-Affected Firms.”¹⁷

Claims Administration Improvements

From a claims administration standpoint, the timing and magnitude of last year’s cats were especially challenging, observes Mitch Balter, Aon Benfield’s executive managing director of client operations. Balter explains that this marked the first time that “collateralized markets were challenged with a notable volume of claims activity.”

To help insurers pay claimants faster, there were several hurdles to overcome. Most premium payments started in June and July, leaving little time for fund accrual. Because of the number of events, including wildfires, the letter of credit season got a late start, emphasizing the critical need for effective communication between brokers, insurers and reinsurers.

The insurance brokers assembled cat modelers to identify clients most likely to be affected, enabling insurers to pay customers quickly. Insurers agreed to potential pre-funding of paid losses without formal proof of loss reports, Balter says.

Almost all reinsurers could pre-fund losses at the lower limit and retention layers of cat programs; however, Balter explains, “We found that collateral posted was exhausted quickly and actions were needed to obtain additional payments.” To address this, Aon Benfield secured periodic reports on actual and projected payments from their insurer clients to facilitate pre-funding at the higher limit layers and retentions of multi-layer placement.

Insurers deploying e-commerce solutions, particularly ACORD, were able to secure client information immediately and quicken settlement, he observes, due to consistent electronic messaging protocols.

To prepare for the next major cat, Balter says that during renewals Aon Benfield is addressing contract language for collateralized markets to reduce payment delay. For example, policies affected by California wildfires have a 168-hour clause that raises questions regarding start-to-finish dates.

Since the major cat events were practically back-to-back, there were higher-than-anticipated loss adjustment expenses and report delays necessary to pay claims, Balter notes. Developing a method to more quickly determine the cause of damage, such as determining flood versus wind, would also quicken the claims process, he says.

Conclusion

The record-breaking 2017 year of the cats demonstrates the insurance industry’s financial strength and agility to handle a tight succession of intense weather events. Though cat modeling is progressing significantly, there is much work to do.

At the same time, the United States needs to face the unshakable reality of its vulnerability to cat weather events. The concept of environmental sustainability should guide where and how structures are built. Smart community planning requires greater infrastructure investment and Americans must see insurance as a property ownership necessity. The cats are sending the message to better prepare, but will the U.S. take heed?

Annmarie Geddes Baribeau has been covering insurance and actuarial topics for more than 25 years. Her blog can be found at www.insurancecommunicators.com.

¹ “Cat” is actuarial shorthand for catastrophe and will be used throughout this article.
² https://www.ncdc.noaa.gov/billions/events/US/2017 (accessed May 4, 2018).
³ http://news.cision.com/property-casualty-insurers-association-of-america/r/property-casualty-insurance-industry-s-surplus-continued-to-grow-in-2017–despite-15-8-percent-drop-,cm112642
⁴ https://libertymutualgroup.com/about-liberty-mutual-site/investor-relations-site/Documents/Q3_2017_Earnings_Presentation.pdf
⁵ https://www.fema.gov/significant-flood-events
⁶ https://www.fema.gov/blog/2018-01-05/public-and-private-partnerships-strengthen-flood-protection-reinsurance
⁷ https://www.insurancejournal.com/app/uploads/2018/04/Summary-of-the-NFIP-April-2018-and-January-2019-Program-Changes-final.pdf
⁸ https://www.fema.gov/news-release/2018/01/05/fema-expands-its-reinsurance-program-manage-future-flood-risk
⁹ https://www.fema.gov/news-release/2018/04/02/fema-announces-its-intent-transfer-nfip-risk-capital-markets
¹⁰ http://media.swissre.com/documents/2017_financial_report_en.pdf
¹¹ https://www.lloyds.com/news-and-risk-insight/press-releases/2018/03/2017-annual-results-gbp
¹² http://www.miamiherald.com/news/business/biz-monday/article207691339.html
¹³ https://www.texastribune.org/2018/03/14/harvey-elevate-homes-flood-houston-money-costs/
¹⁴ https://ricegis.maps.arcgis.com/apps/Cascade/index.html?appid=6ea5082d69484c7a922bd18705afbf85
¹⁵ https://www.munichre.com/topics-online/en/2017/12/hurricane-harvey
¹⁶ Hurricane Irma: Event Recap Report March 2018, page 45.
¹⁷ https://www.newyorkfed.org/medialibrary/media/smallbusiness/2017/SBCS-Report-on-Disaster-Affected-Firms.pdf, page iv.