III - Catastrophes: Insurance Issues

ISSUES UPDATES

Catastrophes: Insurance Issues

THE TOPIC

DECEMBER 2008

The term “catastrophe” in the property insurance industry denotes a natural or man-made disaster that is unusually severe. An event is designated a catastrophe by the industry when claims are expected to reach a certain dollar threshold, currently set at $25 million, and more than a certain number of policyholders and insurance companies are affected.

Catastrophe losses in 2005 totaled $61.2 billion from 24 disasters. The final tally for Hurricane Katrina losses is $41.1 billion stemming from 1.75 million claims. By contrast, losses for 2007, a year of little hurricane activity in the U.S., were $6.5 billion. For the first nine months of 2008, they were $24.9 billion including estimates for insured damage caused by Hurricanes Gustav and Ike.

The 2006 and 2007 hurricane seasons were much less active than predicted, due in part to changes in weather patterns. While the U.S. escaped the most damaging storms, other countries were hit hard by hurricanes that reached Category 5 in intensity, a level of severity assigned to storms with the highest wind speeds and greatest storm surge and the potential for widespread destruction and loss of life.

Meanwhile, the magnitude of the damage caused by Katrina and the potential damage hurricanes Rita and Wilma might have caused had they not weakened from intense Category 5 hurricanes has triggered a reexamination, not just among insurers and reinsurers but also among public policy and political leaders, of how the United States deals with the financial consequences of such massive property damage and personal loss.

Disaster losses along the coast are likely to escalate in the coming years, in part because of huge increases in development. One catastrophe modeling company predicts that catastrophe losses will double every decade or so due to growing residential and commercial density and more expensive buildings. Data from the Census Bureau, collected by USA Today, show that in 2006 34.9 million people were seriously threatened by Atlantic hurricanes, compared with 10.2 million in 1950. Before the 2005 hurricane season, Hurricane Andrew ranked as the single most costly U.S. natural disaster.

Man-made catastrophes such as the attacks on the World Trade Center can also cause huge losses. The attacks led Congress to pass the Terrorism Risk Insurance Act (TRIA) in November 2002. Since then, TRIA has been reauthorized twice. The latest reauthorization, passed at the end of 2007, extends the law to 2014. TRIA provides a federal backstop for commercial insurance losses from terrorist acts, making it easier for insurers to calculate their maximum losses for such a catastrophe and thus to underwrite the coverage, see report on Terrorism Risk and Insurance.

The typical homeowners insurance policy covers damage from a fire, windstorms, hail, riots and explosions—as well as other types of loss such as theft and the cost of living elsewhere while the structure is being repaired or rebuilt after being damaged. Commercial property insurance policies generally cover the same causes of loss with some variation, depending on the coverages selected. Flood and earthquake damage are excluded under homeowners policies—separate policies are available—but are covered under the comprehensive portion of the standard auto policy, which more than 75 percent of drivers who buy auto liability insurance purchase.

Over the 20-year period 1988 to 2007, hurricanes and tropical storms made up 45.6 percent of total catastrophe losses, followed by tornado losses (26.5 percent), winter storms (7.9 percent), terrorism (7.4 percent), earthquakes and other geologic events (6.3 percent), wind/hail/flood (3.2 percent) and fire (2.6 percent). Civil disorders, water damage and utility services disruption combined represented less than 1 percent. Each year about 6 percent of homeowners file claims.

Related Information

RECENT DEVELOPMENTS

Hurricanes: There were 16 named storms this Atlantic hurricane season and nine hurricanes, making 2008 the year with the fourth-highest number of named storms. The last was Hurricane Paloma, the second strongest November Atlantic hurricane on record, according to meteorologist Jeff Masters, and only the fourth major one to develop in November since records on Atlantic hurricanes began. Among other records set this season, there were three tropical storms in July and all three were active on the same day. Forecasters had predicted an above average number of storms. Combined, these 16 storms produced more than an estimated $11 billion in insured losses. Hurricane Ike was the most costly of the season, with an estimated $ 10.65 billion in insured losses, the fifth-most expensive (in 2008 dollars) among all hurricanes to hit the United States.
Catastrophe Losses: U.S. catastrophe losses for the first nine months of 2008 are an estimated $24.9 billion, according to ISO’s Property Claims Service (PCS), see chart below. This total represents some 2.5 million claims from 36 catastrophes. Third quarter catastrophe claims alone totaled an estimated $11.5 billion with 1.7 million claims resulting from 11 catastrophes in 22 states. States with the highest insured catastrophe losses for the third quarter were Texas, Louisiana, Ohio, Kentucky and Illinois, showing that tropical storm systems can cause damage far inland as well as in coastal states. Losses in Texas reached $6.4 billion.
Tornadoes: This has been one of the deadliest tornado seasons in a decade and may be on track to set a record for the number of twisters. The average annual number of tornado-related deaths for the 10 years, 1997-2006, is 62. More than 120 people have died in storms so far this year. About 1,000 tornadoes occur each year, according to the National Oceanic and Atmospheric Administration, but this year 1,390 tornadoes were officially listed for the first seven months, a record. The annual record is 1,817, set in 2004.
A study of tornado losses by A.M. Best, published in April 2008, notes that tornado losses of $1 billion and higher are becoming more frequent. Since 1953, tornadoes and associated weather events have caused almost 57 percent of all catastrophe losses on average, the report states. In 2007 they generated 69 percent—in part because the cost of damage from hurricanes in the U.S. that year was low. According to Risk Management Solutions, each year there is a 95.5 percent probability that losses from tornadoes and hail in six states will exceed $1billion. The six states are: Texas, Oklahoma, Kansas, Nebraska, Colorado and Iowa. There is a 69 percent probability that losses will exceed $2 billion in those states and a close to 20 percent probability that losses will exceed $4 billion.
Wildfires: According to the National Interagency Fire Center, as of December 5 some 77,580 wildfires across the country had burned 5.3 million acres, not as many as seemed probable earlier in the year when fires in California destroyed more than 1,000 homes and other structures as a result of an unusually dry spring. So far, the fires in California this November have claimed close to 1,000 homes, from mobile and modular homes to mansions, causing serious insured losses but not as high as in 2007. Estimates of damage average $800 million, whereas losses from the Witch wildfire in October 2007 totaled $1.3 billion. October is the peak of the wildfire season.
Researchers are discovering that embers blown by the wind during wildfires cause most of the fires that burn homes. Also, homes that are less than 15 feet apart are more likely to burn in clusters. In such cases, fire is often spread by combustible fences and decks connected to houses, a study by the Institute for Business & Home Safety found. Thirty-eight states have wildfire risks, the Institute says, and the risk of wildfires keeps growing as more homes are built in wildland areas, some five million in California alone. Among the preventative features recommended in the study were noncombustible siding, decking and roofing materials; covered vents; and fences not connected directly to the house. In addition, combustible structures in the yard such as playground equipment should be at least 30 feet away from the house and vegetation 100 feet away.
Property Insurance Availability and Affordability and Insurer Profitability: The availability of property insurance in coastal counties along the eastern seaboard from Florida to Cape Cod and the cost of that coverage have become grave concerns as insurers pull back from high-risk areas to reduce future potential hurricane losses and request to raise rates to levels commensurate with the risk they are assuming. Some observers wonder why rates don’t drop significantly when the industry was highly profitable in 2006 and 2007. Profits in an industry like insurance must be seen over the long term. In Florida a single hurricane or a string of large losses can wipe out profits from previous years or even decades. According to the Insurance Information Institute, from 1993 to 2003 the rate of return on net worth for all U.S. homeowners insurers was 2.8 percent, compared with 25 percent for Florida homeowners insurers. But when the years 2004 and 2005 are included, the picture is reversed. Over the period 1990-2006, the rate of return for U.S. homeowners insurers averaged -0.7 percent. For Florida insurers it averaged -38.1 percent, despite 2006 being a profitable year as a whole. Profits in other states cannot be used to subsidize rates in Florida or elsewhere and rates charged must be based exclusively on past trends and expected future losses in that state.
Proposals/Legislation Stemming from 2004/2005 Hurricanes: Many proposals have been put forward for dealing with property insurance issues. One goal has been to reduce disputes over whether damage was caused by wind or flood. Legislation that reauthorized and reformed the National Flood Insurance Program included a provision that would have added optional wind coverage. It passed in the House in May 2007 but the optional wind provision was removed from the Senate version. The optional wind proposal may be reintroduced in the new Congress.
In a report released in May 2008 that underlined the difficulties in implementing such a program, the Government Accountability Office said that the homeowners most likely to purchase the optional wind coverage would be those with the highest likelihood of wind damage (a concept known as adverse selection in the insurance industry), making deficits likely; that a new distribution network would have to be created because insurers currently sell most flood insurance through the federal/private “Write-Your-Own” program (see report on Flood Insurance) and if wind was added they would not want to sell a coverage that competed with their own homeowners business which includes coverage for wind; and that the flood insurance program is already burdened by $17 billion in debt as a result of the 2004/2005 hurricanes, making it difficult to take on a new and volatile wind program.
In a hearing on the bill, insurers stressed that most government-run property insurance programs aimed at providing coverage to high-risk policyholders, such as coastal property owners, operate at a deficit. Regulators are under political pressures to keep rates down in both the private market and state-operated pools, which, in turn, leads to larger pools as private insurers withdraw from high-risk areas, and to higher deficits. If rates for wind coverage are commensurate with the risk and wind coverage is optional, as proposed, few homeowners will purchase it when they can obtain a much cheaper policy through the state. While many in the insurance industry oppose the wind/flood coverage proposal, several large homeowners insurers support the concept.
An associate professor at the Washington and Lee School of Law in Virginia, Adam Scales, has suggested that insurers sell a policy that covers both wind and flood. The federal government would reimburse insurers for the food portion of claims. A similar proposal has been discussed by the National Association of Insurance Commissioners and one major homeowners insurer is considering such a concept. The company has not made a formal proposal to Congress but has discussed the plan with federal legislators, among others. The basic flood insurance portion of the policy would be sold at the same price as the federal program but policyholders would be able to buy additional coverage.
Another proposal stemming from the 2004/2005 hurricanes, The Homeowners Defense Act (H.R. 3355), introduced in the House by two Florida legislators, would allow states to transfer the risk of catastrophic natural disasters from undercapitalized state-run insurance entities, such as the Florida Citizens Property Insurance Corporation, to the private market. The transfer, together with a federal government loan program, would ensure that state entities have the funds after a disaster to make good on their financial commitments to property owners. To accomplish this, a consortium would be created to provide technical assistance and facilitate the transfer of risk to private markets, through for example, catastrophe bonds, see report on reinsurance. The loan program would provide liquidity and long-term financing to the state entities participating in the program. In the Senate, a similar measure (S. 2310) was introduced by Senator Clinton. As a Senator, Obama said that he would support such a program.
Another suggestion that relies on the federal government to set risk-based rules and underwriting guidelines for a specially designated “wind zone” has been put forward by two leading property insurers and insurance agent and brokerage organizations. The plan would provide a comprehensive, private market approach to improve the affordability and availability of windstorm insurance for homeowners in coastal areas, supporters say. The proposal is based four concepts: a uniform set of rules applied to wind coverage for wind zones from Texas to Maine; risk-based, actuarially sound rates using approved standards and wind risk models; federal reinsurance sold at cost for extreme events such as a hurricane that caused losses in excess of $100 billion; and incentives for state and local governments to adopt federal guidelines for appropriate building codes and land use planning.
Most state proposals have been aimed at alleviating the property insurance availability and affordability crisis rather than solving the long-term problem that has led to rates that have been too low for the risk assumed and over development of coastal areas. Growth continues. In Florida, for example, where 80 percent of property lies in coastal areas, the insurance crisis is seen as a threat to the state’s economy.
Catastrophe Funds: Initially after Hurricane Katrina, many states vowed to consider state catastrophe funds. More recently, in most states where state catastrophe funds have been proposed the idea has been rejected by lawmakers. Many question whether such programs could succeed without federal backing. Recently, the National Conference of Insurance Legislators rejected a resolution to support the creation of state-based catastrophe funds. The White House was among the first to criticize proposals to provide a federal backstop for natural catastrophes as totally inappropriate and characterized the insurance availability problems in coastal states as “self-inflicted,” meaning that if a state sets a ceiling on what can be charged and, as a result, insurers are unable to make a profit and leave the state, the state is to blame.
Proposals for a Federal Backstop: These generally envisage a three-layer plan: 1) policies sold by individual insurance companies; 2) state or regional catastrophe pools that provide reinsurance to insurers doing business in the state; and 3) a national megacatastrophe fund. Some insurance groups are in favor of a federal role while others are not. Some say that under the current system the federal government (and hence taxpayers) pay for rebuilding in any case through government grants and low interest loans and that the funds would be better spent in an organized and predictable fashion. Other insurers say that worldwide there is enough reinsurance capacity to protect U.S. primary insurers against catastrophe losses and that people who choose to live in disaster-prone areas should not be protected from the cost of their decisions through subsidies from people who choose to live in a less risky location. They believe the solution is for Congress and state legislatures to develop more stringent building codes and tax incentives for homeowners to prepare for hurricanes. If there is a federal role, it should be limited to providing liquidity through temporary loans to state or regional catastrophe pools rather than serving as a reinsurer.
State Responses: Florida has responded to the potential for increased hurricane activity by assuming greater financial risk in the event that the state is hit by a major storm. Legislation passed in April 2008, the Homeowners Bill of Rights (SB 2860), exacerbated the problem by extending the Citizens Property Insurance Corporation rate freeze for another year until the end of 2009, making what was once the market of last resort the primary market. Lawmakers failed to reduce the amount of reinsurance available under the Hurricane Catastrophe Fund, see below, as suggested by some state officials who were concerned about its claims paying ability in the likely event that the state cannot sell enough bonds to raise money. SB 2860 also imposes more regulation on insurers, requiring them to pay uncontested claims faster and increases the fines regulators can impose on them.
In South Carolina, homeowners who make their homes more resistant to hurricane damage can now get sales and income tax reductions and discounts on homeowners insurance. Legislation passed in June 2007 also allows them to set up tax-deductible hurricane savings accounts to fund large deductibles in the event of damage or to use the savings to pay construction costs themselves if they go without insurance altogether. Under the same bill, insurance companies will get premium tax credits for writing full coverage homeowners insurance in wind pool areas. In addition, the wind pool’s boundaries have been expanded to cover more communities and its policyholders are required to purchase flood insurance.
In Maryland, a bill (H.B.1353) passed by the legislature in April 2008 seeks to address lawmakers’ concerns about the availability and affordability of property insurance in coastal areas of the state—the Eastern Shore and Southern Maryland. It requires companies to obtain prior approval for withdrawal from coastal areas and for hurricane deductibles above 5 percent of the policy limit. It also requires insurers to offer discounts to property owners who take steps to reduce catastrophe losses.
In Louisiana, legislation providing financial incentives to insurers that agreed to assume policies from the state’s insurer of last resort was passed in 2007. The goal was to make homeowners insurance more affordable and reduce the size of the Louisiana Citizens Property Insurance Corporation. Many of the insurers that have applied are new companies; some were initially set up in Florida to assume policies from that state’s insurer of last resort. In addition, Louisiana will allow insurers that write new business in the state to apply to the insurance department for permission to adopt new hurricane deductibles based on the property’s distance from the Gulf of Mexico.
Reducing Catastrophe Losses: An indication of the potential savings from upgrading building codes and stringent enforcement of existing codes comes from the National Institute of Building Sciences, which estimates that society saves an average of $3.65 for every federal dollar spent on mitigation.
In Florida, the insurance department has adopted the Home Structure Rating System, a scale from 1 to 100 that scores homes based on their ability to withstand damage from high winds. The system implements a bill enacted in 2006. Homeowners who make their homes more resistant to damage from hurricane force winds are now seeing a larger discount on the wind coverage portion of their homeowners insurance premium, depending on the extent to which mitigation features such as hurricane shutters, roof coverings and shape, and the way the roof is attached reduce potential wind damage. In Broward County, for example, the program has saved participants an average of $385, or 20 percent, according to the Florida Department of Financial Services. A state home inspection program offered at no charge has shown thousands of homeowners how to reduce their home's vulnerability to storm damage. Some received grants for retrofitting.
Many states have passed legislation requiring insurers to offer discounts for strengthening their homes, including Louisiana and South Carolina and others have upgraded their building codes. In Mississippi, a state that lacked a statewide building code, the Governor approved H.B 1465 in March 2008. The measure requires that all new buildings in cities and counties with building codes be based on current standards and provides funding for training officials to enforce the code. The insurance industry was part of the Coalition to Build a Stronger Mississippi, which was instrumental in getting the law passed. California recently strengthened its building code, incorporating international building and fire standards and state-specific codes for earthquake and wildfire-prone zones.
The Institute for Business and Home Safety (IBHS) is creating a research center to test building and construction components for durability when exposed to high winds, wind-driven water, earthquakes and hail as well as maintenance-related concerns like plumbing system failure and interior fires. The results will be used in consumer education and advocacy campaigns.
Increasingly, consumers are embracing the idea of living in homes that can better withstand severe windstorms and other disasters. Nearly 2,500 “fortified homes,” which incorporate specific safety design features supported by the IBHS, have been completed or are in various stages of construction in 14 different states, IBHS says, including states in the Midwest. In February 2008, a disaster-resistant home was completed in Seattle, an area vulnerable to earthquakes, and in April, the first of more 100 homes manufactured to “fortified” standards was completed in Louisiana. Builders of various types of disaster resistant structures in a number of states are finding that the public’s appetite for stronger homes has been stimulated by Hurricane Katrina, forecasts of continuing hurricane activity and the inevitability of a severe earthquake in the Midwest and West at some point in the future. In Mississippi the wind pool has agreed to give owners of homes built to a fortified standard a 25 percent credit toward the windstorm part of property insurance policies initially, and a lesser amount over the next four years, according to the IBHS. In Alabama, the Beach Pool is offering discounts for homes built to fortified standards.
Validating the concept of “fortified” homes, all but three of the 17 homes built to the original criteria on the Bolivia Peninsula in Gilchrist, Texas survived Hurricane Ike’s high winds. The three that were damaged were knocked off their foundations by flying debris from nonfortified homes, which were reduced to slabs.
Residual Markets: Growth of state-run property insurers is shifting the financial burden of potential hurricane-related damage to all policyholders and taxpayers in these states as they devise ways to fund the claims they will have to pay. By year-end 2007, these insurers had a $670 billion in exposure to loss, compared with $54.7 billion in 1990.
In Texas the Texas Windstorm Insurance Association (TWIA) is facing some 87,000 claims as a result of damage caused by Hurricane Ike. Insurance companies are being assessed $430 million, of which $230 million will be offset or recoupable through credits on the premium tax, the state tax that all insurers are assessed in every state based on their premiums written in that state. Funds are also being transferred to the TWIA from the Catastrophe Reserve Trust Fund ($370 million). Together, these funds will reach the threshold or provide the retention needed before the TWIA can access its reinsurance. All of these funds total $2.1 billion. This assessment follows an earlier one after Hurricane Dolly. Insurers will be assessed again to cover any additional losses above $2.1 billion. The Texas FAIR plan has up to $300 million available and does not expect to assess insurers.
Over the years, the legislature has failed to pass legislation to help fund the residual market, but the pool received funds to purchase reinsurance and recently received a 12.3 rate increase. Increases are capped at 10 percent by law but exceptions can be made for catastrophic losses. Coverage for homes and businesses is available in the 14 coastal counties, including those adjacent to Louisiana and part of Harris County, see report on the residual market. The Texas pool has grown from 68,000 policyholders in 2001 to more than 229,000 as of October 30, 2008 and its exposure to loss to more than $65 billion as insurers concerned about hurricane damage reassess their exposure to losses along the Gulf coast. The TWIA had asked the legislature for permission to issue bonds to shore up its finances. Insurance companies must fund any shortfall but may gradually offset some of the assessments through premium tax credits over a period of years.
In Florida, Citizens Property Insurance Corporation, the state’s insurer of last resort, has become Florida’ s largest insurer. When it was established in 2002, it was expected that it would slowly shrink by transferring policies to private insurers through depopulation programs that provide financial incentives to assume pool policies. Now regulators are trying to reduce the size of the pool by making sure policyholders who are selected by “take-out” companies are aware that they have the option to transfer. Twelve take-out companies approved by the insurance department in 2008 are expected to remove about 900,000 policies this year. Rates offered by the take-out companies will be comparable or lower than Citizens and policyholders that receive an offer have the option of remaining with Citizens. Policies tagged for take out are all west of I-95, outside the area considered highest risk. Citizens’ rates have been frozen until the end of 2009. Starting in 2009, new underwriting exclusions will lower the pool’s overall risk exposure, see report on residual markets. Since 2003, hundreds of thousands of homeowners insurance policies have been returned to the private market but at the same time new policies are being written.
In Mississippi, under legislation passed in March 2007, additional funds will be transferred to the Mississippi Windstorm Underwriting Association, along with a portion of the revenue received from state insurance premium taxes for a four-year period, so that it can build up reserves. In addition, the pool will be able to surcharge policyholders directly if it has to issue bonds or repay loans and insurers will be able to pass on to policyholders their share of assessments for deficits.
In South Carolina, the wind pool was expanded in 2007 to additional counties, reducing the number of policies cancelled by private insurers who can now issue a property policy without wind coverage since this can be purchased separately from the pool.
Florida Hurricane Catastrophe Fund: Insurers in Florida are asking the legislature to consider reducing the state’s Hurricane Catastrophe Fund’s exposure to loss to $16.5 billion or even less. A bill enacted in special session in January 2007 created a three-year program that allows insurers to buy more reinsurance from the state-run reinsurer, the Florida Hurricane Catastrophe Fund, thus reducing their reinsurance costs and potentially allowing them to offer homeowners insurance at lower prices. However, the Fund could find itself short of money in the event of a devastating storm because of the current credit crisis and the effect that has had on the municipal bond market. In a worst case scenario, the Fund could be required to pay out $27.8 billion in losses but it can raise only an estimated $3 billion under today’s municipal bond environment. That, together with its current $10.29 billion in reimbursement capacity would leave a potential shortfall of $14.49 billion. But the likelihood of having to pay out $27.8 billion in the near future is remote, according to Fund officials. A bill that would have reduced the Fund’s exposure to loss by $3 billion was introduced in the 2008 legislative session but not passed. The Fund faced a $1.4 billion deficit after the demands made on it by the 2005 hurricane season. The deficit is being funded by insurance policy surcharges. Claims from Hurricane Wilma that are being reopened or flied for the first time as a result of efforts by independent adjusters will cause the surcharges to be extended for another two years to 2014. If the Fund’s exposure is reduced, some insurers will have to buy additional reinsurance in the private market, raising their expenditures for reinsurance.

THE TEN MOST COSTLY CATASTROPHES, UNITED STATES (1)

			Insured loss ($ millions)
Rank	Date	Peril	Dollars when occurred	In 2007 dollars (2)
1	Aug. 2005	Hurricane Katrina	$41,100	$43,625
2	Aug. 1992	Hurricane Andrew	15,500	22,902
3	Sep. 2001	World Trade Center, Pentagon terrorist attacks	18,779	21,981
4	Jan. 1994	Northridge, CA earthquake	12,500	17,485
5	Oct. 2005	Hurricane Wilma	10,300	10,933
6	Sep. 2008	Hurricane Ike	10,655	10,655 (3)
7	Aug. 2004	Hurricane Charley	7,475	8,203
8	Sep. 2004	Hurricane Ivan	7,110	7,803
9	Sep. 1989	Hurricane Hugo	4,195	7,013
10	Sep. 2005	Hurricane Rita	5,627	5,973
(1) Property coverage only. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2007 dollars by the Insurance Information Institute. (3) Estimated. Expressed in 2008 dollars. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

INSURED LOSSES, U.S. CATASTROPHES, 1998-2007 (1)

Year	Number of catastrophes	Number of claims (millions)	Dollars when occurred ($ billions)	In 2007 dollars (2) ($ billions)
1998	37	3.6	$10.1	$12.8
1999	27	3.2	8.3	10.3
2000	24	1.5	4.6	5.5
2001	20	1.5	26.5	31.0
2002	25	1.8	5.9	6.8
2003	21	2.7	12.9	14.5
2004	22	3.4	27.5	30.2
2005	24	4.4	62.3	66.1
2006	33	2.3	9.2	9.5
2007	23	1.2	6.7	6.7
(1) Includes catastrophes causing insured losses to the industry of at least $25 million and affecting a significant number of policyholders and insurers. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2007 dollars by the Insurance Information Institute. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

MAJOR U.S. CATASTROPHES, 2008

As of December 16, 2008 ($ millions)

Date	Catastrophes	States	Estimated insured loss (1)
First quarter
Jan. 4-9	Wind, hail, tornadoes, flooding, freezing, ice, snow	AR, CA, IL, IN, KS, MI, MO, NY, OH, OK, OR, WA, WI (2)	$745

Feb. 5-6	Wind, hail, tornadoes	AL, AR, IN, KY, MS, OH, TN, TX (2)	955

Mar. 15-16	Wind, hail, tornadoes	GA, SC	560

Total first quarter losses			3,545 (3)

Second quarter
May 22-26	Tornadoes, storms	CO, IA, KS, MN, NE, OK, WY	1,325

Total second quarter losses			7,110 (4)

Third quarter
Jul. 23	Hurricane Dolly	TX	525
Aug. 18-25	Tropical Storm Fay	AL, FL, GA	245
Sep. 1	Hurricane Gustav	LA	2,100
Sep. 6	Tropical Storm Hanna	NC, VA	80

Sep. 12-14	Hurricane Ike	AR, IL, IN, KY, LA, MO, OH, PA, TX	10,655

Total third quarter losses			14,255 (5)

Year to date			24,910
(1) Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Possibly other areas. (3) Includes nine events. (4) Includes 16 events. (5) Includes 11 events. Note: Catastrophes are assigned serial numbers by the Property Claim Services (PCS) Unit of ISO when the insured loss to the industry resulting from an occurrence reaches at least $25 million and affects a significant number of policyholders and insurers. Source: ISO's Property Claim Services Unit.

MAJOR U.S. CATASTROPHES, 2007

As of April 2008 ($ millions)

Date	Catastrophes	States	Estimated insured loss (1)
First quarter
Mar. 1-2	Tornadoes	AL, GA	$500

Total first quarter losses			1,255 (2)

Second quarter
Apr. 13-17	Flooding, hail, tornadoes, wind	CT, DE, DC, GA, LA, ME, MD, MA, MS, NH, NJ, NY, NC, PA, RI, SC, TX, VT, VA	1,350
May 2-3	Flooding, hail, tornadoes, wind	TX	100
May 4-8	Flooding, hail, tornadoes, wind	IA, SD, MO, KS, MN	260

Total second quarter losses			2,300 (3)

Total third quarter losses			1,250 (4)

Oct. 21-24	Witch wildland fire	CA	1,300

Total fourth quarter losses			1,905 (5)

Total losses (full year)			$6,710
(1) Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Includes seven events. (3) Includes six events. (4) Includes six events. (5) Includes four events. Note: Catastrophes are assigned serial numbers by the Property Claim Services (PCS) Unit of ISO when the insured loss to the industry resulting from an occurrence reaches at least $25 million and affects a significant number of policyholders and insurers. Source: ISO's Property Claim Services Unit.

TOP 15 MOST COSTLY HURRICANES IN THE UNITED STATES

($ millions)

				Estimated insured loss (1)
Rank	Date	Location	Hurricane	Dollars when occurred	In 2007 dollars (2)
1	Aug. 25-30, 2005	AL, FL, GA, LA, MS, TN	Katrina	$41,100	$43,625
2	Aug. 24-26, 1992	FL, LA	Andrew	15,500	22,902
3	Oct. 24, 2005	FL	Wilma	10,300	10,933
4	Sep. 12-14, 2008	AR, IL, IN, KY, LA, MO, OH, PA, TX	Ike	10,655	10,655 (3)
5	Aug. 13-14, 2004	FL, NC, SC	Charley	7,475	8,203
6	Sep. 15-21, 2004	AL, DE, FL, GA, LA, MD, MS, NJ, NY, NC, OH, PA, TN, VA, WV	Ivan	7,110	7,803
7	Sep. 17-22, 1989	GA, NC, PR, SC, VA, U.S. Virgin Islands	Hugo	4,195	7,013
8	Sep. 20-26, 2005	AL, AR, FL, LA, MS, TN, TX	Rita	5,627	5,973
9	Sep. 3-9, 2004	FL, GA, NC, NY, SC	Frances	4,595	5,043
10	Sep. 15-29, 2004	DE, FL, GA, MD, NJ, NY, NC, PA, PR, SC, VA	Jeanne	3,655	4,011
11	Sept. 21-28, 1998	AL, FL, LA, MS, PR, U.S. Virgin Islands	Georges	2,955	3,758
12	Oct. 4, 1995	FL, AL, GA, NC, SC, TN	Opal	2,100	2,856
13	Sep. 14-17, 1999	NC, NJ, VA, FL, SC, PA, 10 other states	Floyd	1,960	2,439
14	Sep. 11, 1992	Kaui and Oahu, HI	Iniki	1,600	2,364
15	Sep. 5, 1996	NC, SC, VA, MD, WV, PA, OH	Fran	1,600	2,114
(1) Property coverage only. Does not include flood damage covered by the federally administered National Flood Insurance Program. (2) Adjusted to 2007 dollars by the Insurance Information Institute. (3) Estimated. Expressed in 2008 dollars. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

THE TEN MOST COSTLY WILDLAND FIRES IN THE UNITED STATES (1)

($ millions)

			Estimated insured loss
Rank	Date	Location	Dollars when occurred	In 2007 dollars (2)
1	Oct. 20-21, 1991	Oakland Fire, CA	$1,700	$2,587
2	Oct. 25-Nov. 4, 2003	Cedar Fire, CA	1,060	1,194
3	Oct. 21-24, 2007	Witch Fire, CA	1,300	1,300
4	Oct. 25-Nov. 3, 2003	Old Fire, CA	975	1,098
5	Nov. 2-3, 1993	Los Angeles County Fire, CA	375	538
6	Oct. 27-28, 1993	Orange County Fire, CA	350	502
7	Jun. 27-Jul. 2, 1990	Santa Barbara Fire, CA	265	420
8	May 10-16, 2000	Cerro Grande Fire, NM	140	169
9	Jun. 23-28, 2002	Rodeo Chediski Complex Fire, AZ	120	138
10	Sep. 22-30, 1970	Oakland & Beverly Hills Fire, CA	25	133
(1) Property coverage only for catastrophic fires. Effective January 1, 1997, Property Claim Services (PCS) Unit defines catastrophes as events that cause more than $25 million in insured property damage and that affect a significant number of insureds and insurers. From 1982 to 1996, PCS used a $5 million threshold in defining catastrophes. Before 1982, PCS used a $1 million threshold. (2) Adjusted to 2007 dollars by the Insurance Information Institute. Source: ISO's Property Claim Services Unit; Insurance Information Institute.

TOP TEN STATES FOR WILDLAND FIRES RANKED BY NUMBER OF FIRES, 2007

Rank	State	Number of fires	Number of acres burned
1	California	9,093	1,087,110
2	Georgia	8,726	837,895
3	North Carolina	7,000	54,658
4	Florida	4,918	578,346
5	South Carolina	3,842	17,064
6	Oklahoma	3,519	69,907
7	Alabama	3,373	64,262
8	Tennessee	3,361	48,572
9	Oregon	2,561	648,046
10	Arizona	2,240	101,381
Source: National Interagency Coordination Center.

BACKGROUND

The insurance industry tracks catastrophes to monitor claim costs, assigning a number to each catastrophe. Each claim arising from the event is tagged so that total industrywide losses can be tabulated. The term catastrophe is often used in the property insurance industry in a narrow way to mean a catastrophic event that exceeds a dollar threshold in claims payouts. This figure has changed over the years with inflation and the increase in development of areas subject to natural disasters. Starting in 1997 the catastrophe definition was raised from $5 million to $25 million in insured damage. As a result, the number of recorded catastrophes and the aggregate losses attributed to catastrophes has been on average lower since 1997 than in earlier years.

While $25 million is a large figure to most people, there have been four catastrophes that fall into the megacatastrophe category, greatly exceeding that amount. The first two, Hurricane Andrew (1992) and the Northridge earthquake (1994), were both watershed events in that they were far more destructive than most experts had predicted a disaster of this type would be. The third, the terrorist attack on the World Trade Center in 2001, altered insurers’ attitudes about man-made risks worldwide. Hurricane Katrina (2005), the fourth catastrophe, is not only the most expensive natural disaster on record but also an event that intensified discussion nationwide about the way disasters, natural and man-made, are managed. It also focused attention on the federal flood insurance program, see report on Flood Insurance.

Hurricane Andrew: Hurricane Andrew, which hit the Bahamas and Southern Florida August 23-24, 1992, and then moved across the Gulf of Mexico to strike portions of Louisiana and other southeastern states on August 25-26, was the costliest natural disaster in U.S. history before Hurricane Katrina. With peak wind gusts of almost 200 mph, the hurricane flattened whole communities, leaving in its wake a wasteland of debris. Eleven property/casualty insurers became insolvent due to Hurricane Andrew (10 in Florida and one in Louisiana) and others were financially impaired. Some of the state’s largest homeowners insurance companies had to be rescued by their parent companies and others had to dig deep into their surplus to pay Hurricane Andrew claims. Allstate, for example, paid out $1.9 billion, $500 million more than it had made in profits from its Florida operations from all types of insurance and investment income on those funds over the 53 years it had been in business. In total there were 680,239 claims, including 161,400 for damage to automobiles.

The Northridge Earthquake: The Northridge earthquake measured 6.8 on the Richter scale. It jolted the San Fernando Valley, 20 miles northwest of downtown Los Angeles, on January 17, 1994, causing more than 60 deaths and 12,000 injuries and destroying some 8,000 homes. More than 114,000 buildings were damaged and some 430,000 claims were filed. In both natural disasters, Hurricane Andrew and the Northridge Earthquake, homeowners accounted for the bulk of claims and claim dollars.

The Destruction of the World Trade Center: The World Trade Center disaster impacted many kinds of insurance companies, particularly commercial lines companies. Claims were also filed with life insurance companies as well as personal lines insurers. The number of people known to have died as a result of the attacks on the World Trade Center complex has been officially set at 2,976. More than 35,000 claims were filed in New York State alone, according to the New York Department of Insurance. Broken down by type, two-thirds were commercial claims and one third personal, mostly property claims. Lost income and extra expense claims for the cost of getting the business back on track, part of property insurance, represented more than one quarter of the dollars paid out. More than 5,600 workers compensation claims were filed. Other claims were paid by insurance companies to businesses that suffered indirect losses in other parts of the country. These were not reported to the New York Insurance Department.

Other large U.S. man-made disaster losses in the last two decades include those stemming from the Los Angeles riots in 1992, at $775 million, and the World Trade Center bombing in 1993, at $510 million, see charts above.

Hurricane Katrina: Katrina, the storm that most affected attitudes about managing natural disaster risk, made landfall first in Florida on August 25, 2005 as a Category 1 storm, then gathered strength as it crossed the warm waters of the Gulf of Mexico, ultimately hitting Louisiana on August 29 as a strong Category 3 storm. The hurricane generated more than 1.7 million claims, more than half of the total in Louisiana. The bulk of the claims, 1.2 million, were for personal property. There were 346,000 claims for damaged vehicles and some 156,000 commercial claims. Claims payments to businesses accounted for half of the $40.6 billion bill for insured losses.

Katrina left more devastation and a higher reconstruction bill in its wake than any previous storm, in part because of extensive commercial and residential development along the Gulf Coast; the record breaking storm surge, reported to be as high as 29 feet in some areas; and the concentration of energy related and other high value businesses in its path. Katrina’s hurricane force winds at landfall covered a wide area, extending for 250 miles, twice as far as Hurricane Andrew. Because the damage was so severe and widespread, the demand for materials and skilled labor quickly exceeded the readily available supply, pushing up construction prices and hence the cost of property insurance claims.

The 2005 hurricane season exposed many weaknesses in the nation’s preparedness for megadisasters. For example, many people in flood zones had failed to buy flood insurance, see report on Flood Insurance, and many communities in harm’s way did not have or had not enforced strong building codes, which would have reduced the amount of wind damage. In addition, the disasters drew attention to the need to reconsider land use patterns in areas most vulnerable to storm damage.

Hurricanes: A hurricane's winds revolve around a center of low pressure expressed in millibars, or inches of mercury, and the entire system moves slowly. Hurricanes are categorized on the Saffir/Simpson intensity scale, which ranges from 1 to 5, reflecting a hurricane's wind and ocean-surge intensity. Below is the Saffir/Simpson Classification System.

THE SAFFIR/SIMPSON CLASSIFICATION SYSTEM FOR HURRICANES

Category	Wind Speeds	Pressures	Storm Surge	Damage
1	74-95 mph	Greater than 980 mb	4-5 ft.	Light
2	96-110 mph	965-979 mb	6-8 ft.	Moderate
3	111-130 mph	945-964 mb	9-12 ft.	Extensive
4	131-155 mph	920-944 mb	13-18 ft.	Extreme
5	More than 155 mph	Less than 920 mb	Greater than 18 ft.	Catastrophic

A windstorm becomes a tropical storm when average wind speeds reach 39 mph. The hurricane season runs from June 1 to November 30, but the height of the season is from mid-August to mid-October.

The number and severity of hurricanes seems to run in cycles. Experts now think these cycles are influenced by several factors: the amount of rainfall in the Sahel region of West Africa just below the Sahara Desert and the pressure and temperature conditions there, the direction of equatorial stratosphere winds, Atlantic Ocean and Caribbean Sea level pressure readings and the oceanic warm-water pattern known as El Nino. Between 1947 and 1969, a rainy period in the Sahel, 17 major hurricanes (Category 3 or greater) struck the East Coast of the United States, compared with 10 between 1970 and 1991, when the Sahel was experiencing a drought. Climatologists believe changing climatic conditions in the tropics signal a period of more intense hurricane activity.

New research suggests that the degree of hurricane activity in the Atlantic Basin is not a proxy for the number of storms that are going to make landfall along the U.S. coastline. According to researchers at AIR Worldwide, the probability of landfall is linked most closely to a storm’s genesis, or where it forms, rather than the number of tropical storms in the Atlantic. Genesis patterns change from year to year. The key to understanding why in some years the number of storms making landfall in the United States is high and in others it is low is to compare long-term genesis and storm tracking patterns, the AIR study notes.

Many of the most severe hurricanes have originated near the Cape Verde Islands off the West Coast of Africa. Recently, hurricane experts have been studying what has become known as the "Atlantic Conveyor Belt," a stream of warm water that moves north up the East Coast from Florida and loops around to Greenland, where it cools and turns south again. The belt of water flows at different speeds in 20 to 30 year cycles. For the past 25 years, it has flowed slowly but is now accelerating, creating conditions favorable to hurricanes. Some scientists attribute the increased hurricane activity to global warming but others say there no evidence to support this. There is some indication that higher water temperatures over the Gulf of Mexico are contributing to the overall greater intensity of the storms.

Florida is the state most vulnerable to hurricanes. Reliable records on hurricanes only go back to the 1870s. Sketchy accounts of earlier disasters exist in ship’s logs and journals. Now, geologists, supported in part by insurers, hope to add to the written record by examining sediments at the bottom of coastal lakes and marshes. During a hurricane, sand and shell debris get swept into these waters. Research so far suggests that between 1,000 and 2,000 years ago, there were five or six Category 4 and 5 hurricanes in the Florida panhandle.

Data compiled by the National Oceanic and Atmospheric Administration (NOAA) on the 30 most powerful storms over the period 1900 to 1996 show that more than 40 percent of the damage they caused occurred in southeast Florida. Of the 158 hurricanes that hit the United States, 47 hit Florida and 26 of those struck the Southeast Florida coast.

Recently, computer simulation models have been developed that can mesh long-term disaster information with current demographic data to produce potential claims losses for any given geographical location under various scenarios. This information allows insurers to better differentiate between high- and low-risk areas in states such as Florida, where formerly, in times of less sophisticated risk delineation, the entire state may have been considered high risk. In addition, computer programs designed to help underwriters evaluate a building's potential damage from windstorms allow insurers to price industrial property insurance coverages more accurately. The ability to generate such information has also led insurers to reassess their business strategies.

But quality and type of building construction are not the only factors that influence the extent of damage a windstorm can cause. Others include the number and type of trees in an area and the type of soil, both of which affect the potential for losses due to falling trees. Soft woods, such as pine, tend to have shallow roots so that they are more easily uprooted than hard woods like oak, particularly in places with sandy soil. Storm surges will cause more damage where the developed land is close to sea level rather than elevated.

Coastal Development: A study published in 2004 by NOAA, based on U.S. Census data, found that in 2003, 53 percent of the nation’s population—153 million people—lived in coastal counties (including those that abut the Great Lakes), which in total make up 17 percent of the country’s land mass. For the purposes of the study, a coastal county must be part of a coastal watershed but it does not have to have a shoreline. These ratios have remained steady since 1970 but the number of people has steadily increased. Twenty-three of the 25 most densely populated areas are coastal. Put another way, in 1960 an average of 187 people were living on each square mile of the U.S. coast, excluding Alaska. In 1994, that figure was 274 per square mile, and it is expected to reach 327 people by 2015. The West Coast is in the highest earthquake risk zone.

Between 1980 and 2003, the population of coastal counties grew by 33 million people, or 28 percent. Florida grew 75 percent, Texas 52 percent and Virginia 48 percent. More growth is expected with the highest growth expected in the southernmost part of Florida, the region most exposed to hurricanes. Coastal counties in the Carolinas and Georgia are also expected to see considerable population increases. Large increases are forecast for the Houston, Texas area and Florida’s central Gulf Coast. According to population growth projections by the U.S. Census Bureau, by 2030 more than 12 million additional people will be living in Florida and Texas.

Exposure to windstorms and high property values combine to make Florida the state with the highest potential for losses, and New York's Long Island the second highest. A 2007 study by AIR Worldwide put the value of insured coastal property in hurricane-prone states—states bordering on the Atlantic Ocean and Gulf of Mexico—at $8.89 trillion. The value of residential and commercial coastal property in Florida alone was almost $2.46 trillion. This represented 79 percent of the state’s total insured property values. In New York it was $2.38 trillion, representing 62 percent of the total. Other states where insured coastal property values exceeded 50 percent of the state’s total are Connecticut, Maine and Massachusetts.

The growth and concentration of property values in hurricane-prone areas has pushed to the forefront of public policy debates the issue of coastal development and hidden insurance subsidies. Subsidies exist in various aspects of the property insurance transaction. First, they exist where rates for property insurance are no longer commensurate with risk because it is politically unpalatable to raise rates to actuarially justified levels. Second, there are subsidies in the pooling arrangements that were set up to make sure people living along the coast can obtain property insurance. When these pools have insufficient funds to pay claims, the shortfall is picked up by insurance companies, which may then pass the cost on to all property insurance policyholders in the state through explicit policy surcharges, as in Florida, or indirectly in the form of higher property insurance rates.

Catastrophe Deductibles: After Hurricane Andrew, with computer-based models of storms, coastal development patterns and increasing values all indicating how vulnerable insurers were to large weather-related losses, homeowners insurers had difficulty finding the reinsurance coverage they needed to protect their own bottom line. Many homeowners insurers couldn't obtain reinsurance coverage unless they agreed to greatly reduce their potential maximum losses from such events through higher deductibles. These deductibles exist in regions prone to hail as well as hurricane damage. They are generally equal to a percentage of the structure's insured value as opposed to a straight dollar amount, such as $1,000. Eighteen states and the District of Columbia have what have become known as hurricane deductibles.

Percentage deductibles for windstorm losses, which may be mandatory in some coastal areas of a state, vary from 1 percent of the home's insured value to 15 percent, depending on many factors that differ from state to state, and sometimes from insurer to insurer, including the home's insured value and the "trigger," the nature of the event to which the deductible applies. In some states or portions of a state, policyholders have a "buy back" option — paying a higher premium in return for a traditional dollar rather than percentage deductible. The percentage deductibles may apply to the entire state or just part of it (see Hurricane and Windstorm Deductibles paper).

For hail damage, in addition to instituting percentage of limits deductibles, some insurers in some states are providing coverage for roofs on a depreciated (actual cash value) basis, rather than replacing a damaged roof with a new one. Some insurers are offering a discount for hail- resistant roofs or imposing a surcharge for roofs that are not hail resistant to encourage people to replace old roofs with new, less damageable ones.

Earthquakes: On the West Coast, earthquakes represent the greatest threat. Statistics show that since 1900, earthquakes have occurred in 39 states and have caused damage in all 50. About 5,000 quakes can be felt each year, with some 400 capable of causing damage to the interior of buildings and 20 capable of causing structural damage. A major earthquake (8.2 on the Richter scale) in San Francisco today could cause as much as $84 billion in damage. However, a major earthquake on the East Coast, though more unlikely, could cause much greater damage. Because earthquakes in the eastern part of the country tend to be thrust-fault quakes, which produce an up-and-down motion rather than the horizontal side-to-side common in California, damage could be 10 times greater, according to seismic experts. The degree of damage also depends on other variables such as the structure of the building and soil conditions (see Earthquakes: Risk and Insurance Issues paper).

A study by Dr. Haresh Shah of Risk Management Solutions and Stanford University, which draws on data from the 1994 Northridge quake and the 1995 quake in Kobe, Japan, suggests the ground shaking at a quake's epicenter can be more violent than expected. This finding has pushed up earlier estimates for loss of life and property damage in the event of a megaquake. An 8.3 magnitude quake in San Francisco, the same in intensity as the quake in 1906, could cause up to 8,000 deaths and between $80 and $105 billion in insured losses, with total losses as high as $225 billion. (Total damage from the Kobe, Japan, quake was $147 billion, of which only $4.1 billion was insured.) New estimates of the potential damage to Tokyo in a major earthquake are numbing. A quake similar to the one that destroyed the city in 1923 could cause as much as $4.3 trillion in total losses.

California insurers collected only $3.4 billion in earthquake premiums in the 25-year period prior to the Northridge earthquake and paid out more than $15.3 billion on Northridge claims alone. After the Northridge earthquake, insurers were reluctant to offer homeowners insurance because they feared additional earthquake exposure could potentially bankrupt them. In response to this crisis in the homeowners insurance market, in 1995 California lawmakers passed a two-part bill that allowed insurers to offer a new earthquake policy with a maximum deductible of 15 percent and created a privately funded, state-run earthquake pool.

Earthquake Insurance: Insurers doing business in California must offer earthquake insurance to their homeowners insurance policyholders, either a policy from the California Earthquake Authority (CEA) or, if they do not participate in the pool, a policy that they underwrite. Several dozen companies now write earthquake insurance in California in addition to the CEA. The CEA became operational in December 1996, with a $10.5 billion funding package. The CEA could now pay claims caused by a quake more than twice as destructive as Northridge since with each passing earthquake-free year, its claims paying ability increases. Passage of the CEA legislation opened up the homeowners market (see Earthquake paper). More recently, the CEA created a supplementary policy to broaden coverage. Nevertheless, only a small portion of the state’s property owners buy earthquake insurance and the percentage appears to grow smaller as the time span since the last major quake increases.

Tornadoes: Each year, about 1,200 tornadoes with gusts of wind as high as 200 mph touch down in the United States. Tornado intensity is measured by the Fujita scale which runs from 0 through 5, the most damaging, based on the maximum speed of three-second wind gusts and the potential for damage. The scale incorporates 28 different damage indicators based on damage to a wide variety of structures from shopping malls to trees. Though generally not as costly in terms of insured values as hurricanes because they strike a more limited geographic area, tornadoes are more frequent. They can cause severe damage and, particularly before the advent of tornado warnings, many deaths. In the decade, 1965-1974, they were responsible for an average of 141 deaths each year, compared with 63 in the 10 years 1998-2007. The peak of the tornado season is April through June or July. Spring tornadoes tend to be more severe and strike the Southeast, which is more densely populated than the Great Plains, thus causing more deaths than those in the summer months. In addition, the South has more mobile homes than other regions. Mobile homes are vulnerable to tornado damage.

Since 1990 the number of tornadoes has generally exceeded 1,000 a year. In the three preceding decades, the only year in which there were more than 1,000 tornadoes was 1973, when 1,102 were reported. This increase may reflect greater ability to detect tornadoes.

Wildland Fires: Fire plays an important role in the life of a forest, clearing away dead wood and undergrowth to make way for younger trees. But for much of the last century, fire-suppression policies focused on extinguishing wildfires as quickly as possible to preserve timber and, increasingly, real estate. These policies have led to the accumulation of brush and other vegetation that is easily ignited and serves as fuel for wildfires. In an effort to reduce the incidence of wildfires, increasingly fire officials are promoting “prescribed burns” to eliminate the accumulated debris. In recent years, most of the large fires with significant property damage have occurred in California, where some of the fastest developing counties are in forested areas. However, wildfires are a growing threat in other states, particularly when there is a drought, as more homes are built in woodland areas that were once wild.

The year 2006 set a national record both in the number of forest fires and their size. A total of 96,385 fires were reported and 9.9 million acres of forest and woodland burned, a 125 percent increase over the 10-year average, according to the National Interagency Fire Center. Fifty percent of the fires occurred in the southern section which stretches from Texas to Georgia. In 2005, more than 8 million acres burned. Over the past decade, the number of acres burned has increased as drought, record-setting heat and the build-up of dead trees and undergrowth together with residential development have combined to heighten the risk of fire. According to a University of Wisconsin study, in the West more than 8.6 million new homes have been built within 30 miles of a national forest since 1982.

A scientific study published in the September 4, 2007 issue of the Proceedings of the National Academy of Sciences examined the role houses play in the spread of wildfires. It found that making entire neighborhoods of homes fire resistant slows down the spread of fire. The likelihood of fires spreading from one site to another is dictated in large part by the amount and proximity of fuel—flammable materials such as dry undergrowth, trees that burn easily and unprotected wooden structures. When houses are not fire resistant, they add greatly to the fuel load and potential for the fire spreading because they quickly burn down to the ground. When homes are fire resistant, not only are they less likely to burn but they also act as a fire break, reducing the ultimate size of the fire and enabling it to be brought under control more easily. The Institute for Business and Home Safety (IBHS), a group supported by the insurance industry, is conducting research into how construction, building components, landscaping practices and homeowner behavior play a role in the spread of wildfires, using data from insurance companies that insured structures in the “burn zone,” regardless of whether or not they sustained damage.

Fire damage is covered under a homeowners insurance policy whatever the cause of the fire unless the person insured under the policy commits arson by intentionally setting fire to the structure. As a result of the greater potential for fire losses where homes are built on mountainous and forested sites, insurers are increasingly requiring homeowners whose property is at risk to take precautions to slow the spread of fire. Such measures include installing fire-resistant roofs and creating a “defensible zone” around the home by removing debris, overhanging tree branches and other items located close to the building that can become fuel for a fire.

Reinsurance: Just as individuals and businesses buy insurance to protect their assets, primary insurers, the companies that sell insurance to consumers, buy reinsurance to protect their bottom line. Reinsurance is sold in layers, reaching up into the millions of dollars to protect insurance companies from possible, but statistically highly unlikely events such as a $100 million court award or an extraordinary number of homeowners claims as a result of a hurricane or a fast-spreading brush fire.

Retentions and coinsurance, through which insurers share the risk at various levels with their reinsurers, as well as coverage amounts, have increased dramatically over the past decade. It is now patently evident that the cost of catastrophes, both natural and man-made, can be in the tens of billions of dollars. Hurricane Katrina cost more than $40 billion but a hurricane hit to Miami or a major terrorist attack could cost much more.

Before September 11, terrorist coverage was provided to commercial policyholders essentially without charge because the risk of an attack was considered remote. Immediately following the disaster, reinsurers said they would no longer offer terrorist coverage to the insurance companies they reinsure because they could not price this unprecedented risk and the availability of coverage for terrorist events is still limited. Legislation that made the federal government the reinsurer of last resort for major terrorist attacks was passed by Congress in November 2002 and extended in 2005 for two more years, making it easier for insurers to calculate maximum losses and therefore to underwrite the coverage (see report on Terrorism Risk and Insurance). The program was reauthorized by Congress at the end of 2007 for another seven years.

The shortage of catastrophe reinsurance capacity in the United States following Hurricane Andrew, particularly for large national insurance companies, also prompted insurers, reinsurers, investment banks and others to look for new ways to spread the risk of natural disasters (see Reinsurance paper). Increasingly, the capital markets are being seen as a large resource that can be tapped to cover claims at the higher levels (after reinsurance has been exhausted) where there is a low probability of loss. The advantage to investors is diversification. Catastrophe losses are unrelated to the usual speculative risks, which are generally economic. While the number of transactions involving the capital markets is still relatively small, some observers expect catastrophe risk to be securitized and made available to investors on a regular basis.

Pricing: The price of an insurance policy reflects the costs of paying claims covered by that policy, as well as an insurance company's costs for such items as reinsurance. Not surprisingly, reinsurance costs as well as direct claims costs are lower where the risk is low. For example, if a community has a good fire department and ready access to water to extinguish fires, serious fires in that community will likely be fewer than in similar communities that lack a good fire department. The same principle applies to windstorms: premiums will reflect the normal level of windstorm claims in a given community.

How does the insurance industry deal with extraordinary costs such as the $40.6 billion in insured losses for Hurricane Katrina? Prior to Hurricane Andrew, insurance companies accounted for hurricanes and other catastrophes with a special premium amount known as a "catastrophe loading" to spread the risk over a period spanning 30 to 40 years. Sometimes they used data from several states subject to the same kind of catastrophes to develop the average annual cost of catastrophes. However, since the mid-1990s more sophisticated computer modeling techniques have become available. Insurers now base their rates, in part, on sophisticated computer models that combine meteorological data with their own exposure data. The meteorological data show the probability of a natural disaster occurring in a particular geographical area and the exposure data indicate how many of the company's policyholders are likely to be affected and to what extent, i.e., what the insurer's potential losses from that event are likely to be. Models can also assess the losses a specific company or building might sustain in a terrorist attack.

Special Catastrophe Programs: In the United States special pools, known as Beach and Windstorm Plans, ensure the availability of windstorm insurance for properties close to the ocean. These pools, which exist in seven states along the Gulf and Atlantic coasts in various forms, are operated by property insurers doing business in the state, and in some cases by the state itself. Hawaii created a fund but this was disbanded in December 2000.

New Zealand, Japan, France, Norway and the Netherlands als