It has been fascinating watching the progression of the forecasted path for Hurricane Joaquin — what a perfect example this is of the importance of a modern data and analytics platform!
The big news is that the hurricane is not expected to make landfall on the East Coast of the U.S., but the new forecast depends as much on analytics and big data as it does on actual changes in the storm’s path. The spotlight is now on the European Center for Medium-Range Weather Forecasts (the European model) vs. the Global Forecast System (GFS) run by the National Weather Service. The New York Times has a great article discussing the reasons for the changing forecast and, crucially, the differences between the two models.
This is an excellent lesson for insurers to see the power of modern data and analytics in action and what happens to models when they are not using the advanced capabilities available today. Fortunately, investment in analytics continues to rise, as detailed in SMA’s recent report, Maturing Technologies in Insurance. Almost three in four insurers are increasing their investment in analytics over the next three years. 48% of P&C insurers, in fact, are planning to increase their analytics investments by more than 10% annually during that time.
In recent conversation with key CAT modelers, we have learned that they are working to use their weather data and insights at a more granular level than ever before in coming releases. The advance of these CAT model tools creates opportunities for insurers in search of better predictive capabilities on weather events. An upgrade to the GFS model has been planned by the end of the year, taking advantage of soon-to-be-available computing capacity. Once it is up and running, it will be interesting to see how the upgraded GFS model compares with the current European model, especially when applied to future CAT events.
Insurers can take the continuing story of Hurricane Joaquin as a wake-up call — not only is analytics a critical area for investment, but the quality of the information and the computing capacity available have a major impact on how useful predictive modeling can be.
Munich Re is known as a conservative giant of international reinsurance, so it might seem odd that it is joining the National Flood Insurance Program (NFIP) in covering U.S. flood. A quick look at the opportunity shows why the plan makes sense.
U.S. inland flood insurance is an untapped source of non-correlated premium unlike any other in the world. The market is dominated by an incumbent market maker that is in trouble because it offers an inferior product that cannot price risk correctly (this paper nicely summarizes the problems at NFIP). So, here is what the new entrants are seeing:
Contrary to industry beliefs, flood is insurable. The tools are present to accurately segment risk.
Carriers offering flood capacity will differentiate themselves from competitors. This will give them a leg up on the competition in a market that is highly homogeneous. Carriers not offering flood will likely disappear.
The market is massive, with potentially 130 million homes and tens of billions of dollars at stake.
Let’s go into details.
Capital Into a Ripe Market
The U.S. Flood Market
As most readers of Insurance Thought Leadership already know, many carriers have flood on the drawing board right now. The Munich Re announcement was not really a surprise. We all know there will be more announcements coming soon.
Let’s summarize the market reasons for the groundswell of private insurance in U.S. flood.
The most obvious characteristic of the market is the size. For the sake of this post, we’ll just consider homes and homeowner policies. Whether one considers the number of NFIP policies in force as the market size (about 5.4 million policies in 2014), the number of insurable buildings (133 million homes) or something in between, there is clearly a big market. And the NFIP presents itself as the ideal competitor – big, with a mandate not necessarily compatible with business results.
So, there is no doubt that a market exists. Can it be served? Yes, because the risk can be rated and segmented.
Low-Risk Flood Hazard
To be clear: A low-risk-flood property has a profile with losses estimated to be low-frequency and low-severity. In other words: Expected flood events would rarely happen, and not cause much damage if they do. For many readers, joining the words “low-risk” and “flood” together is an oxymoron. We strongly disagree. Common sense and technology can both illustrate how flood risk can be segmented efficiently and effectively into risk categories that include “low.”
Let’s start with common sense. Flood loss occurs because of three possible types of flood: coastal surge, fluvial/river or rain-induced/pluvial (here is more information on the three types of flood). The vast majority of U.S. homeowners are not close enough to coastal or river flooding to have a loss exposure (here is a blog post that explores the distribution of NFIP policies). Thus, the majority of American homeowners are only exposed to excess surface water getting into the home. We’d be willing to wager that most of the ITL readership does not purchase flood insurance, simply because they don’t need it. That is the common-sense way of thinking of low-risk flood exposure.
How does the technology handle this?
There is software available now that can be used to identify low-risk flood locations (as defined by each carrier), supported by the necessary geospatial data and analytics. Historically, this was not the case, but advances in remote sensing and computing capacity (as we explored here) make it entirely reasonable now, with location-based flood risk assessment the norm in several European countries. Distance to water, elevations, localized topographical analyses and flood models can all be used to assess flood risk with a high degree of confidence. In fact, claims are now best used as a handy ingredient in a flood score rather than as a prime indicator of flood risk.
How to Deliver Flood Insurance in the U.S.
Deliver Flood Insurance to What Kind of Market?
Readers must be wondering at the size of market, because we offered two distinctly different possibilities above – is it about 5 million to 10 million possible policies, or 130 million policies? The difference is huge – the difference is between a niche market and a mass market.
The approach taken by flood insurers thus far is for a niche market. The current approach probably has long-term viability in high-risk flood, and the early movers that are now underwriting there are establishing solid market shares, cherry-picking from the NFIP portfolio.
On a large scale, though, the insurance industry’s approach needs to be for a mass market.
Here is a case study describing the mass market opportunity:
Using InsitePro (see image below), you can see that the property is miles and miles away from any coastal areas, rivers or streams. More importantly, the home is elevated against its surroundings, so water flows away from the property, which is deemed low-risk.
The area has no history of flooding, and this particular community has one of the most modern drainage systems in the state.
Screenshot of InsitePro, courtesy of Intermap Technologies. FEMA zones in red and orange
Using Google Maps street view, we can estimate that the property is two to three feet above street level, which adds another layer of safety. Also, this view confirms that the area is essentially flat, so the property is not at the bottom of a bathtub.
And, as with most homes in California, this property has no basement, so if water were to get into the house it would need to keep rising to cause further damage.
To an underwriter, it should be clear that this home has minimal risk from flooding. As a sanity check, she could compare losses from flood for this property (and properties like it in the community) to other hazards such as fire, earthquake, wind, lightning, theft, vandalism or internal water damage. How do they compare? What are the patterns?
For this specific home, the NFIP premium for flood coverage is $430, which provides $250,000 in building limit and $100,000 in contents protection. The price includes the $25 NFIP surcharge.
This is a mind-boggling amount of premium for the risk imposed. Consider that for roughly the same price you can get a full homeowners policy that covers all of these perils: fire, earthquake, wind, lightning, theft AND MORE! It is crazy to equate the risk of flood to the risk of all those standard homeowner perils, combined! We provided this example to show that even without all the mapping and software tools available for pricing, what we can quickly conclude is that the NFIP pricing for these low-risk policies is absurdly high. Whatever the price “should” be for these types of risks, can you see that it MUST be a fraction of the price of a traditional homeowner’s policy? Don’t believe that either? Consider that the Lloyd’s is marketing its low-risk flood policies as “inexpensive,” and brokers tell us privately that many base-level policies will be 50% to 75% less expensive than NFIP equivalents.
The news gets even better. There are tens of millions of houses like this case example, with technology now available to quickly find them. These risks aren’t the exception; these risks can be a market in their own right. Let the mental arithmetic commence!
Summary: Differentiate or Die!
The Unwanted Commodity
Most consumers of personal lines products don’t have the time or the ability to evaluate an insurance policy to determine whether it provides good value. Regrettably, most agents and brokers don’t have the time to help them either. So, when shopping for a product that they hope they will never use and that they are incapable of truly understanding, consumers will focus on the one thing they do understand: price.
Competing on price becomes a race to the bottom (yay! – another soft market) and to death. But there is an opportunity here – carriers that compete on personal lines/homeowner insurance with benefits that are immediately apparent (like value, flexibility, service, conditions and, inevitably, price) have a rare chance to stake out significant new business, or to solidify their own share.
The flood insurance market is real, and it’s big enough for carriers to establish a healthy and competitive environment where service and quality will stand out, along with price. Carriers that would like to avoid dinosaur status can remain relevant and competitive, with no departure from insurance fundamentals – rate a risk, price it and sell it. It’s obvious, right?
Which carriers will be decisive and bold and begin to differentiate by offering flood capacity? Which carriers will evolve to keep pace or even lead the pack into the next generation of homeowner products? More importantly, which of you will lose market share and cease to exist in 10 years because you didn’t know what innovation looks like?
In December 2005, just three months after Katrina savaged the Gulf Coast, we edited On Risk and Disaster, a book on the key lessons that the storm so painfully taught. The book was very different from most of the post-mortems that focused on the country’s lack of preparedness for the storm’s onslaught. It focused sharply on how to reduce the risk of future disasters—and how to understand how to help those who suffer most from them.
One of the most important findings highlighted by the book’s 19 expert contributors was that the storm affected lower-income residents far more than others. Reducing the exposure to potential damage before disasters occur, especially in the most hazard-prone areas, is one of the most important steps we can take. To achieve this objective in low-income areas, residents often need help to invest in measures to reduce their losses. Failing to learn these lessons will surely lead to a repeat of the storm’s awful consequences.
Now, 10 years after Katrina struck, six lessons from the book loom even larger.
1. Disasters classified as low-probability, high-consequence events have been increasing in likelihood and severity.
From 1958 to 1972, the number of annual presidential disaster declarations ranged between eight and 20. From 1997 through 2010, they ranged from 50 to 80. The National Oceanic and Atmospheric Administration reported that the number of severe weather events—those that cause $1 billion in damage or more—has increased dramatically, from just two per year in the 1980s to more than 10 per year since 2010. That trend is likely to continue.
2. Most individuals do not purchase insurance until after suffering a severe loss from a disaster—and then often cancel their policies several years later.
Before the 1994 Northridge earthquake in California, relatively few residents had earthquake insurance. After the disaster, more than two-thirds of the homeowners in the area voluntarily purchased coverage. In the years afterward, however, most residents dropped their insurance. Only 10% of those in seismically active areas of California now have earthquake insurance, even though most people know that the likelihood of a severe quake in California today is even higher than it was 20 years ago. Moreover, most homeowners don’t keep their flood insurance policies. An analysis of the National Flood Insurance Program in the U.S. revealed that homeowners typically purchased flood insurance for two to four years but, on average, they owned their homes for about seven years. Of 841,000 new policies bought in 2001, only 73% were still in force one year later, and, after eight years, the number dropped to just 20%. The flood risk, of course, hadn’t changed; dropping the policies exposed homeowners to big losses if another storm hit.
3. Individuals aren’t very good at assessing their risk.
A study on flood risk perception of more than 1,000 homeowners who all lived in flood-prone areas in New York City examined the degree to which people living in these areas assessed their likelihood of being flooded. Even allowing a 25% error margin around the experts’ estimates, most people underestimated the risk of potential damage; a large majority of the residents in this flood-prone area (63%) underestimated the average damage a flood would cause to their house. It is likely that “junk science,” including claims that climate change isn’t real, leads many citizens to problems in assessing the risks they face.
4. We need more public-private partnerships to reduce the costs of future disasters.
Many low-income families cannot afford risk-based disaster insurance and often struggle to recover from catastrophes like Katrina. One way to reduce future damages from disasters would be to assist those in hazard-prone areas with some type of means-tested voucher if they invest in loss-reduction measures, such as elevating their home or flood-proofing its foundation. The voucher would cover both a portion of their insurance premium as well as the annual payments for home-improvement loans to reduce their risk. A program such as this one would reduce future losses, lower the cost of risk-based insurance and diminish the need for the public sector to provide financial disaster relief to low-income families.
5. Even if we build stronger public-private partnerships, individuals expect government help if they suffer severe damage.
Just before this spring’s torrential Texas rains, there was a huge battle in the Texas state legislature about whether local governments ought to be allowed to engage in advance planning to mitigate the risks from big disasters. Many of the forces trying to stop that effort were among the first to demand help when floodwaters devastated the central part of the state. Even the strongest believers in small government expect help to come quickly in times of trouble. We are a generous country, and we surely don’t want that to change. But jumping in after disasters strike is far more expensive than taking steps in advance to reduce risks. Everyone agrees that the cost curve for disaster relief is going up too fast and that we need to aggressively bend it back down.
6. Hurricanes tend to grab our attention—but there are other big risks that are getting far less attention.
Hurricanes are surely important, but winter storms, floods and earthquakes are hugely damaging, too. Too often, we obsess over the last catastrophe and don’t see clearly the other big risks that threaten us. Moreover, when big disasters happen, it really doesn’t matter what caused the damage. Coast Guard Adm. Thad Allen, who led the recovery effort after Katrina, called the storm “a weapon of mass destruction without criminal intent.” The lesson is that we need to be prepared to help communities bounce back when disasters occur, whatever their cause; to help them reduce the risk of future disasters; and to be alert to those who suffer more than others.
The unrest that rocked Baltimore following Freddie Gray’s death reminds us that Adm. Allen’s lesson reaches broadly. The riots severely damaged some of the city’s poorest neighborhoods and undermined the local economy, with an impact just as serious as if the area had been flooded by a hurricane. Many of the same factors that bring in the government after natural disasters occurred here as well: a disproportionate impact on low-income residents, most of whom played no part in causing the damage; the inability to forecast when a random act, whether a storm surge or a police action, could push a community into a downward spiral; and the inability of residents to take steps before disasters happen to reduce the damage they suffer.
Big risks command a governmental response. Responses after disasters, whatever their cause, cost more than reducing risks in advance. Often, the poor suffer the most. These issues loom even larger in the post-Katrina years.
Natural disasters have become more frequent and more costly. We need to develop a much better strategy for making communities more resilient, especially by investing—in advance—in strategies to reduce losses. We need to pay much more attention to who bears the biggest losses when disasters strike, whatever their cause. We need to think about how to weave integrated partnerships involving both government and the private and nonprofit sectors. And we need to understand that natural disasters aren’t the only ones our communities face.
Sensible strategies will require a team effort, involving insurance companies, real estate agents, developers, banks and financial institutions, residents in hazard-prone areas as well as governments at the local, state and federal levels. Insurance premiums that reflect actual risks coupled with strong economic incentives to reduce those risks in advance, can surely help. So, too, can stronger building codes and land use regulations that reduce the exposure to natural disasters.
If we’ve learned anything in the decade since Katrina, it’s that we need to work much harder to understand the risks we face, on all fronts. We need to think about how to reduce those risks and to make sure that the least privileged among us don’t suffer the most. Thinking through these issues after the fact only ensures that we struggle more, pay more and sow the seeds for even more costly efforts in the future.
This article was first published on GovEx and was written with Donald Kettl and Ronald J. Daniels. Kettl is professor of public policy at the University of Maryland and a nonresident senior fellow at the Brookings Institution and the Volcker Alliance. Daniels is the president of Johns Hopkins University.
In 2013, Amazon CEO Jeff Bezos announced to the world that the online retailer would begin to develop a “drone-to-door” delivery service for its loyal customers. Dubbed Amazon Prime Air, the system would deliver packages directly to your doorstep in just 30 minutes after an order is placed, setting a new and higher bar for “fast delivery.”
However, after a variety of issues and concerns were addressed by increasing regulations added by the Federal Aviation Administration (FAA), it appeared that Bezos’ announcement would never get off the ground. But after two years of waiting for the FAA, Amazon will finally get to test these drones on U.S. soil — or, should I say U.S. air? — bringing customers one step closer to having their Tide detergent refilled by a delivery drone.
Despite the U.S. government dragging behind on approvals, for retail and civilian use, sales for drones aren’t expected to slow any time soon. Companies like Teal Group, an aerospace research firm, estimates that sales of both military and civilian drones will total more than $89 billion by 2023.
Other big companies, such as State Farm and AIG, are also getting into the drone business. In fact, State Farm is the first insurance company in the U.S. to receive regulatory approval to test drones for commercial use. With drones popping up in so many different industries, it makes me wonder, what impact will drones have on companies’ customer experience — good and bad?
State Farm plans on changing the insurance industry for the better, using drones to aid in natural disaster relief. For instance, instead of State Farm spending the money (and time) to ship hundreds of claims adjusters out to natural disaster sites to assess damages, the company will send only a handful of agents equipped with a drone partner to more efficiently survey damaged property.
Jason Wolf, a property defense attorney and shareholder at the Florida-based firm, Koch Parafinczuck & Wolf, stated in an interview to ClaimsJournal.com: “I envision a time when, after a catastrophe, an adjuster pulls up to a neighborhood and opens the trunk of his car and presses a few buttons on his tablet device, and the drone does an immediate survey of everything and streams it all right to his tablet device, and he knows exactly where to go first and what’s most significant within minutes. Costing very little money, the insurance company has a sense of everything that needs to be done in a very short amount of time.”
Imagine all the headaches this could mitigate for customers and employees after the chaos caused by unfortunate losses created by natural disasters.
It’s interesting, too, how this type of surveying will require additional training, but training we might be familiar with. Much like a police officer who trains alongside his dog in a K-9 unit, insurance adjusters will train alongside their partner – only, in this industry, it would be a drone.
While there is debate in the insurance world about how drones will operate, one thing is for sure – they will be operated and used to speed up services and save on cost, making customers’ lives a little easier. As such, claims assessment aided by a drone will yield quick turnarounds and an even quicker payout to the insured.
Additionally, insurance companies will start offering drone insurance to owners of unmanned aircraft systems (UAS). RiskandInsurance.com noted that the general types of coverage that will be required for the use of UAS and ancillary business activities will include liability, personal injury, invasion of privacy, property and workers’ compensation. The publication also mentioned that, given the conservative nature of the insurance industry, carriers could place stricter guidelines on drone coverage than the FAA does.
Once regulated and insured, drones will be sent out into the community to collect data. For example, what if someone’s home flooded? Well, insurance companies could send their drone to the flooded house and survey the area for all damages, speeding up the process for families affected.
There is also the use of drones for the collection of data by third parties. Imagine that Ford is looking to target advertisements for a new truck to areas where the road conditions would demand the use of four-wheel drive. Ford hires an agency to send out drones to specific cities where it is looking to advertise.
This drone will collect data on road conditions and take images of cars on the road to make sure a majority of drivers are in trucks, and will then report back on economic conditions. Ford doesn’t want to be advertising where citizens can’t or won’t pay for the product.
In a world becoming more drone-centric, these types of background checks and data collections via UAS will become increasingly more frequent.
The government review process for a drone is 120 days, but, by the end of the process, Amazon says the technology of the drone submitted for regulation is outdated. Therefore, Amazon must update its filing and submit to the FAA for regulation, starting the 120-day review process all over again.
The other concern of the FAA is air traffic. Coming down with a few regulations on drone flight, the FAA is requiring that drone controllers have sight of the drone at all times and that they must operate under 400 feet.
Exelis, a global aerospace, defense, information and services company, was featured in an article on Engadget recently, discussing its development of an air traffic control system for drones. Nearly ready for testing at the FAA approved drone-testing sites, the low-altitude monitoring system would keep tabs on compact aircrafts flying at or under the mandated 400 feet.
It’ll be interesting to see how industry giants, such as Amazon, overcome these obstacles to create a non-invasive customer experience with drone technology.
Once regulated, the next issue is invasion of civilian privacy. Private and civil liberties advocates have raised doubts about the legitimacy of facial recognition cameras, thermal imaging cameras, open Wi-Fi sniffers, license plate scanners and other sensors commonly used by drones in the civilian sphere.
Civilian uses of drones for hobby are already causing issues, most notably at the White House, but across the country, as well. The LA Times reported last June that while LA Kings hockey fans were celebrating their Stanley Cup victory, a group noticed a drone flying over their heads filming the scene. Angry at the invasion of privacy, the crowd knocked the drone out of the sky using a T-shirt and then smashed it to bits with a skateboard.
In Los Angeles, flying a drone in public is not illegal, but LAPD Cmdr. Andrew Smith commented that, “It was kind of an eye-opener for us, that this something we really need to pay attention to.” While the Kings fans reactions may seem a little over the top, the general population seems to feel the same way when they see a drone overhead.
With no official laws on the books regarding the use of domestic drones, the right to privacy becomes a large topic of concern for many citizens. The American Civil Liberties Union states on its website, “Congress has ordered the Federal Aviation Administration to change airspace rules to make it much easier for police nationwide to use domestic drones, but the law does not include badly needed privacy protections.”
It will be interesting to see how industries promote drone use to their customers, without raising fears about a threat to privacy. After all, customers may not always be right, but they are always the customers.
Drones will also need to be protected from cyber attacks.
“Cyberattacks on your PC – they can steal information, and they can steal money, but they don’t cause physical damage, whereas cyber-attacks in a UAV or a car can cause physical damage, and we really don’t want to open that can of worms,” said Kathleen Fisher, the previous program manager of the DARPA project in a statement to NextGov.com
The Pentagon is currently working on developing code that will protect a Boeing Little Bird unmanned aircraft from being hacked. Defense industry programmers are rewriting software to safeguard the computer onboard the helicopter drone and aim to have the project completed by 2017.
It’s exciting to think about what drone technology will bring to companies and their customers – and to people everywhere. Let’s face it, if we think we have seen the complete potential of what customer experience has to offer, then, well, we’re being naive. The new drone technology will reinvent customer experience once again. And the best part? We all get to see how it unfolds.
The future seems endless for drones. Whether you feel they are an invasion of privacy, or they will begin to make our lives easier and aid society in ways that haven’t even been thought of yet, drones aren’t going anywhere any time soon. If you need to put it in perspective, a white paper featured on Cognizant.com notes that 40,000 drones are expected to deploy in 2015, and this is a number that will continue to increase each year. This industry is ready for take-off.
If you haven’t come face-to-face with a drone yet, don’t worry, you will.
Does the recent string of catastrophes from New Zealand to Mid America to Japan matter to me and my Insurance Program? Should I worry about the impact and record breaking cost of these events? Currently the cost estimate is over 60 Billion dollars and counting. As with so many things in a global environment, are all of these events related and will they have serious implications for insurance pricing in the future?
The simple answer? Yes, they do. Insurance at its core is the ability to collect premiums from many businesses such as your local operation and many thousands of other small to medium size businesses and use those premiums to pay losses for the group. The insurance carrier has to charge a premium that not only is sufficient to pay smaller routine losses, but to also bank premiums for the large multi-billion dollar losses that can occur on an infrequent basis. Every carrier has to predict the potential loss that they could be exposed to from any source and make sure they have the financial strength to pay those claims. No one carrier, no matter how large, is able to take 100% of any loss or losses that might happen without facing financial insolvency. The solution to that problem is to purchase what is called reinsurance. In essence, each carrier pays a premium to another carrier for protection against a truly devastating event such as happened in Japan.
A carrier might have multiple layers of reinsurance with each policy taking a defined portion of any loss such as 5 million of coverage after the paid loss totals 15 million, and these policies each have a defined portion of a loss for a defined premium. These reinsurance premiums are then included in the premium that each policy holder pays each year. Reinsurance premiums can average as much as 15 to 20% of the annual premium you pay as a business owner. If the reinsurance carriers have to participate in the cost of a catastrophe such as Japan or New Zealand for earthquakes or hurricanes or tornadoes, then the premium they charge will increase which will increase the premiums your carrier pays for the protection and thus your individual premiums can go up. It is this ability to spread high dollar losses to numerous carriers that makes insurance work in any situation.
The reinsurance industry is absorbing losses at a record pace over the last six months, but through careful management of assets and surplus has been able to remain solvent and financially able to continue to provide protection. We are starting to see an indication that rates are going to adjust upward to replenish surplus for reinsurance carriers. Increases will be variable based on location, line of business and carrier concentration. The industry is keeping a wary eye on the upcoming hurricane season. If a large event takes place in the United States in a heavily populated area, it could be the final event that generates a rapid increase in pricing at the individual policy level. Stay tuned for further developments.