Catastrophe preparedness: Aligning policyholders and insurers' interests
There is a disconnect when a policy should encourage insureds to reduce exposures but only pays for expenses if damage occurs.
You may not have noticed it, but weather forecasts are getting better, particularly for hurricanes. In fact, a modern five-day Atlantic hurricane track forecast is as accurate as a three-day forecast was in the early 2000s. Useful forecasts now reach nine to 10 days into the future.
This has huge societal benefits, especially for the insurance industry when it comes to policyholders taking precautionary action to a landfalling hurricane. There likely is not one C-suite insurance executive that does not browse the U.S. National Hurricane Center (NHC) website daily during a named storm event to observe the National Hurricane Center’s “Cone of Uncertainty.”
Reducing the ‘Cone of Uncertainty’
It is called the “Cone of Uncertainty” because the further out in time you go, the more uncertain the forecast becomes; however, the hurricane track forecasts have been gradually improving over the last two decades. This means that the range of the “Cone of Uncertainty” is shrinking, much to the benefit of the industry and individuals.
Without question, improvements in forecast accuracy have provided governments with significantly better insights into when and where to order an evacuation and urge homes and businesses to board up and leave. Hurricane Dorian, one of the strongest hurricanes to ever be observed in the Atlantic Basin, is a great example. Even as it made landfall in the Bahamas, approximately 100 miles offshore, only limited coastal evacuation orders were given along the Florida East Coast.
The economic and societal benefits afforded by these progressively more accurate forecasts are obvious, as increasing numbers of people are able to remain in place and avoid unnecessary expenditures and disruption to business. Evacuating and preparing for a hurricane is expensive. Just think of the cost of boarding up a structure with today’s skyrocketing lumber prices, which are up over 200% since April 2020. If policyholders do not end up preparing for a storm, they can save hundreds if not thousands of dollars.
Improvements to hurricane forecasts are getting increasingly harder (this year’s cone has decreased by less than five nautical miles at all forecast times). This is a result of the difficulty in forecasting something as complex as a hurricane in a chaotic, multifaceted system like the Earth’s atmosphere. With bigger and faster computers and more observations, the forecasts will continue to improve, but these increases in accuracy will be incremental.
Aligning the interests of policyholders and insurers
While Dorian caused limited damage to coastal property, amounting to just over $100M to the insurance industry in Florida, and spared homeowners substantial physical damage, this situation can result in a major protection gap for those that did not suffer damage but did take (often expensive) mitigation steps. Since a typical property policy only pays for added expenses if physical damage occurs, no compensation for any preparation or mitigation is provided.
This creates a misalignment of interests when a well-structured policy should encourage insureds to reduce loss exposure. To this effect, encouraging storm preparedness for the potential of a) reduced losses and b) reduced disruption to policyholders should be encouraged. Unfortunately, the current “standard” fails to sufficiently incentivize property owners given the increasing costs of materials.
A simple solution is a “storm preparedness endorsement” allowing for coverage for storm mitigation efforts — irrespective of whether the property sustains actual loss from an event. In this way, policyholders are incentivized to protect their properties in advance of an event potentially headed toward their property. In turn, this is in the insurance company’s interest, as those efforts may result in a significantly smaller loss.
Given the low likelihood the policyholder will need to engage the coverage, cost should be nominal across a portfolio. Supported by the increased forecast accuracy of the last two decades, the coverage aligns the interest of the policyholder and insurance company in reducing ultimate loss, with little moral hazard given the nature of the coverage — mitigation for an anticipated storm impact: a policyholder is only going to undertake mitigation efforts for storms they expect to impact their property and the insurance company can require photo evidence of the implemented protections prior to payment, as is already the practice with other coverages.
A proactive insurance company would simultaneously serve policyholders and minimize risk by actively encouraging policyholders in the path of the storm to take appropriate action and potentially trigger the coverage. With this coverage endorsement, policyholders in or around the “Cone of Uncertainty” are more likely to undertake the supported mitigation efforts. Both the policyholder and insurance company benefit from the protective measures due to a decrease in loss from the event and policyholder disruption.
The practicality/viability of this type of coverage can be demonstrated by the fact that something similar is already being provided (albeit for another peril) by AIG’s Private Client Group for the peril of wildfire. In addition to pre-event loss control assistance, in an actual event, if access is permitted, wildfire mitigation specialists can visit vulnerable properties to help remove combustibles and, when necessary, apply Thermo-Gel for structure and landscaping protection.
On the hurricane side of preparedness, as a member of IBHS, BMS utilizes many of their suggestions to help insurance companies suggest preparedness to their clients. Some of these can be done preseason such as:
- Trimming trees away from roofs and buildings;
- Checking drainage by cleaning out downspouts to limit flooding mishaps, and
- Installing hurricane shutters (if plywood is used it should be at least ¾ inch thick).
With weather forecasting getting better, there is an incentive for the insurance industry to push preparedness, as improved weather forecasts are useful only if appropriate steps are implemented. These suggestions are just a small sample of simple and inexpensive things that can be done preseason or in the hours leading up to hurricane landfall to limit losses. Insurance companies will benefit by taking a more active role in mitigation via incentives.
Andrew Siffert is senior vice president and senior meteorologist, and David Cameron is executive vice president, property treaty at BMS Re. The opinions expressed here are the authors’ own.
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