A New Model For Disasters

The insurance industry and the companies that provide it with risk-assessment tools are reassessing their models in the wake of hurricanes Katrina and Rita
Hurricane Katrina cut a swath through an area of Louisiana and Mississippi that was as large as Great Britain. As a result, insurance analysts and disaster-modeling businesses say the lessons from the storm will filter through their industries for years.

Insurers use software models developed by companies such as Eqecat Inc. and Air Worldwide Corp. to predict the damage a major storm can cause--and their potential liability for insurance payouts. But in Katrina's aftermath, executives at both companies plan to revise their models with new information.

A State Farm assessor looks over damage to rental property in New Orleans after Rita

A State Farm assessor looks over damage to rental property in New Orleans after Rita.

Photo courtesy of NewsCom
Insurance companies, such as State Farm Insurance Co. and Allstate Insurance Co., use the models to predict the impact of hurricanes on their customers. Allstate insures about 21% of all homes in Louisiana and 10% in Mississippi. State Farm insures about one-third of all homes in each state.

Though losses are still being tallied, Katrina's damage is expected to exceed a record $35 billion, says Robert Hartwig, chief economist for the Insurance Information Institute, which compiles statistics for the industry.

The modeling industry got its start after Hurricane Andrew hit southern Florida in 1992, inflicting $14 billion in losses. Eleven insurance companies became insolvent in its aftermath, says Tom Larsen, a senior VP at Eqecat. "Andrew was a seminal event," he says, and Katrina will likely be another.

Major insurance companies buy the software models and apply them to their customer databases to see where they might be over-exposed and how to mitigate the losses. They also analyze Katrina-like scenarios to determine whether their insurance rates are adequate to cover potential risks.

After Katrina, modelers are expected to add variables to their formulas covering the Gulf Coast region, such as how consistently building codes are enforced. In many parts of the area, building codes are inadequate and improperly enforced, Hartwig says. While Texas and Louisiana have state building codes, enforcement is a local option and some localities have no building inspectors.

Updated models will take into account how a major storm like Katrina increases recovery costs. Rebuilding is slower and more expensive after a Katrina-scale storm because of the demand for building materials across a large region. That drives up prices for materials and labor: Plywood prices soared 38% two weeks after Katrina hit, Hartwig says.

Large-scale storms also have a greater impact on insurance coverage for lost profits by shutting down businesses for weeks or months instead of a few days.

Modelers are even accounting for problems with specific building materials. Jayanta Guin, research and modeling VP at Air Worldwide, says he's found that a modern building material widely used in the South called "exterior insulation finish," which provides insulation against heat, peeled off many hotels and high-rise apartment buildings when hit by the one-two punch of Katrina and Rita.

But the models can't account for politics. Insurance commissioners in Mississippi and Louisiana have filed suit to force insurance companies to pay for flood damage, even though the commissioners previously approved the policies that state they don't cover flood damage. "If such litigation were successful, insurers will have no option but to pull back from the region," Hartwig says.

Several insurers say it's too soon to say how Katrina's aftermath will affect their business. Allstate was prepared for the storm because in recent years it reengineered the IT infrastructure that supports its claims-adjustment systems, Allstate CIO Catherine Brune says in an E-mail. But most firms will evaluate their risk-prediction models after processing claims for Katrina-related damage.

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