Hefty recent cat losses well within modellers’ expectations: Verisk

Reinsurers that pay close attention to the predictions of catastrophe risk models should not have been surprised by any of the recent nat cat losses borne by the industry. But recent increases in catastrophe losses are not necessarily being driven by climate change—rises in exposure values and replacement costs are far more pertinent factors.

That is the opinion of Yörn Tatge (pictured), senior vice president and managing director at Verisk Insurance Solutions. He told Intelligent Insurer that the size of losses this year, including Hurricane Ian, are all within a range of expectations.

Specifically, he points to Verisk’s industry exceedance probability (EP) curve, which now suggests that on an annual average basis, catastrophes around the world are expected to cause about $123 billion in insured losses compared to an average of $74 billion in actual losses over the past 10 years.

“As things stand, I believe we are around the $100 billion mark on cat losses so far this year,” Tatge said. “The size of the losses we have seen are very much within expectations. It is perhaps more surprising that it had been so long since a major hurricane made landfall in Florida.”

Verisk’s latest loss estimates for that event specifically are now between $42 and $57 billion, although this estimate does not include claims adjustments, litigation and political pressure to pay out on policies not explicitly covered. He stresses that, whichever loss estimate reinsurers look at, Hurricane Ian should not be a complete surprise. Their reaction is due to the wider challenges they are facing.

“The Florida market had been in turmoil for some time prior to this, plus you have inflation, social inflation and extreme increases in the costs of materials,” he said. “It has been a perfect storm. That has meant people are still not putting their cards on the table when it comes to capacity. They are not talking numbers yet, which is unusual for Baden-Baden.”

He believes the root cause of the problems in markets such as Florida is that the insurance rates paid by consumers are much too low. “They are inadequate. It is cheaper to buy insurance than to storm-proof a house,” he said.

No such thing as secondary

Bernhard Reinhardt, director, consulting and client services, Extreme Event Solutions, Verisk, says a similar gap between reinsurers’ loss expectations and what the models suggest can be seen in Europe. He stated that the past decade has been relatively benign, with average losses sitting at around €6 billion a year.

The past two years surprised the market: 2021 losses were closer to €16 billion and last year they were around €10 billion. “Those years stick out, but our predicted average cat loss for the market is €15 billion,” Reinhardt said.

He addresses a misnomer—a factor often cited by reinsurers as a reason to back away from cat business: so-called ‘secondary’ perils. “There is no such thing,” he said. “Things such as flood and wildfires make up some 50 percent of losses in an average year so they should not be a surprise. People also refer to them as ‘unmodelled’. Maybe that was once true but not any more. In terms of the global EP curve, 95 percent of those losses are modelled.”

Tatge added that reinsurers’ concerns over climate change impacting their catastrophe portfolios are unfounded. Verisk has done extensive studies projecting the impact of climate change in the decades ahead: 2035, 2050 and 2070. He stresses that climate change is a serious challenge, but it is slow-moving.

“If you are mapping out a long-term business strategy and what your capital needs might be in 2035, you need to consider climate change. But the time horizons on standard cat models are up to 10 years; most reinsurance deals are one year. In that context, the models and the way they take climate change into account is fine.”

Bigger drivers

Tatge reiterated the point that the bigger reason cat losses have been increasing for reinsurers is not climate change, but the concentration and value of exposures. “I would not want to downplay the importance of climate change, but inflation and exposure concentration are far bigger drivers right now,” he said.

He suggests the reason some reinsurers have exited the cat space is more to do with having a lack of diversification within their portfolios and the cost and scarcity of the retrocessional capacity some relied on. He notes that the biggest reinsurers have no issue, perhaps making consolidation in the market likely in the future.

The bottom line, Tatge says, is that, until the past couple of years, cat business has been significantly underpriced. As a former re/insurer (he was previously vice president of cat risk management at Zurich Insurance), he says he understands this. Reinsurers must base decisions on long-standing, deep relationships. “There are business pressures. They risk losing clients if they go to high,” he said.

But in tough market conditions such as today, he said, the use of cat models becomes invaluable. “In these difficult times of capacity shortages and a tricky renewal, cat models are more valuable than ever,” Tatge concluded.