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, assign-Insurance Topics Updates at www.iii.org/issues_updates
I.I.I. Insurance Handbook www.iii.org/insurancehandbook 33
Updates at www.iii.org/issues_updates Insurance Topics
Catastrophes: Insurance Issues
ing 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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