August 28, 2017
Hurricane Harvey: A Moment of Truth
Insurers have a golden opportunity to justify the public’s trust. But they also run the risk of failing to live up to expectations.
The first major hurricane to make landfall in the U.S. since hurricanes Dennis, Katrina, Rita and Wilma in 2005, Hurricane Harvey will cause billions of dollars in economic damage and disrupt countless lives. In the wake of massive economic losses and untold human suffering, including loss of life, millions of individuals and businesses will turn to their insurers for help. This will be a make-or-break experience, a real moment of truth.
Insurers will be presented with a golden opportunity to justify the public’s trust and earn the respect of policyholders, regulators, legislators and others in government. But insurers also run the risk of failing to live up to expectations and incurring the wrath of voters and their elected representatives.
See also: Flood Risk: Question Is Where, Not When
The first test may well be distinguishing damage caused by wind from damage caused by flooding, as virtually all insurance policies exclude losses due to flooding (the exception being those policies issued by the National Flood Insurance Program). Insurers will need to be careful, thorough and fair when settling claims.
Equally important, insurers will need to be perceived as having been so, and communication will be key. Insurers would be well advised to do what they can to make policyholders feel they have been treated with respect, dignity and compassion even when their claims must be denied or settled for some amount less than the claimant sought.
Moreover, insurers would be well advised to settle claims as quickly as possible without unduly sacrificing sound loss adjustment and efforts to weed out fraud and abuse.
Finally, with the media sure to draw attention to heartbreaking stories about human tragedy in Harvey’s aftermath, insurers might benefit from doing what they can to shine a light on their efforts to help individuals and businesses recover. Surely it is worth noting that, as others evacuate, insurers gear up to send large numbers of claim adjusters to work in extremely difficult conditions in hard-hit areas.
Hurricane Harvey will also lead to many other moments of truth. For example, the devastation caused by Harvey may well prove to be the first real test at extreme scale of new insurtech created to improve loss adjustment. Will use of drones, aerial imagery, artificial intelligence, digitalization, big data, predictive analytics and the like prove as beneficial as hoped? Will insurtech entrepreneurs and insurers who have invested in these technologies be vindicated? And, on a more positive note, will experience coping with Harvey reveal new opportunities to use emerging technologies to increase speed, efficiency and fairness?
Insured losses from Hurricane Harvey may also test reinsurance mechanisms, including catastrophe bonds, other insurance-linked securities and sidecars. And what about so-called hedge fund reinsurers, which sought to profit by investing insurance float using strategies like those typically employed by hedge funds? Will they continue to participate as claims mount, or will they instead seek to exit the business? Some past catastrophes triggered significant inflows of fresh capital, as investors sensed opportunities to profit from a turn in reinsurance markets. Such was the case following Katrina, Rita and Wilma in 2005. Will the “fast money” come rushing in again, and, if it does, will it prove to also be “smart money”?
All of the above raises the question, “Will Hurricane Harvey lead to a reset of catastrophe models, pricing for hurricane risk and underwriting?” Some past storms, such as Hurricane Andrew in 1992, convinced insurers that they had previously underestimated hurricane risk and thus led to dramatic resets in coastal property insurance markets, with attendant price increases and availability problems. Whether Harvey brings about such a reset seemingly depends on whether current catastrophe models did an adequate job alerting insurers to the risk of an event like Hurricane Harvey. If so, changes in coastal property insurance markets may be muted. If not, expect price increases and availability problems.
Last, and let’s hope least, Hurricane Harvey may test insurers’ enterprise risk management. Prior to Harvey, the property/casualty industry had ample surplus, and most insurers were well capitalized. But surplus was not evenly distributed across insurers, and only the surplus of those insurers that wrote policies covering properties struck by Harvey is available to cover claims from Harvey.
If an insurer only wrote risks in Oregon, its surplus won’t be called upon to cover claims from Harvey. Bottom line, insurers that covered properties affected by Harvey, that were aware of potential losses and that have ample financial resources to cover claims and continue operations can give themselves good grades for enterprise risk management.
On the other hand, Insurers that covered properties affected by Harvey, that were surprised by their losses and that lack the resources to cover claims must give themselves failing grades for enterprise risk management.
And then there is a gray area: insurers that intelligently judged the risk of insolvency to be acceptably small, took a calculated risk and then lost that bet. Though such insurers will fail, it cannot be said that their enterprise risk management failed. Eliminating even the most remote chance of insolvency is not practical. Neither is it economically viable. Sound enterprise risk management consists of: 1) understanding risks; 2) making conscious, intelligent decisions about which risks to take, which risks to avoid, which risks to mitigate and which risks to transfer; and, 3) enforcing controls that keep operations within the bounds established by an enterprise’s appetite for risk.