Catastrophes : Insurance Issues

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.

The magnitude of the damage caused by Katrina and the potential damage Hurricane Rita might have caused had it not weakened from an intense Category 5 hurricane 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 the topic 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.

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. There have been four catastrophes that fall into the megacatastrophe category, greatly exceeding the $25 million threshold.

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 the topic on Flood Insurance.

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