Weathering Rising Insurance Rates

Will climate change drive up your property and casualty insurance rates? Yes, according to executives in the insurance industry, especially if the increasing frequency of damaging storms we saw in 2011 becomes a recurring pattern. The potential impact of changing weather patterns already is putting upward pressure on insurance rates.

"Insurance companies are trying to get their arms around whether there are going to be significant changes in weather patterns," noted Tim Hausmann, chairman and principal of Hausmann-Johnson Insurance. "This is a high-level discussion, but that's a concern for a lot of companies in property-casualty."

Insurance agents are being told there has been substantially more severe weather activity that is increasing the number of claims. While the federal government's statistics show the number of tornadoes actually has fluctuated in recent years, 2011 was a particularly active year for destructive storms, as tornadoes devastated communities like Joplin, Mo. Last year, 1,691 tornadoes were reported in the U.S., but the death toll of 550 people is four times that of the second highest year since 1991 – 130 deaths in the 1,424 storms reported in 1998.

Insurers paid out an estimated $2.2 billion in claims in Missouri alone, much of that as a result of the tornado that ripped through Joplin, according to International Standard Organization's property claim services. Munich Re, a German re-insurance company, estimates that severe thunderstorms and tornadoes cost $25.9 billion in insured losses and $46.6 billion in economic losses in 2011.

While most of those storm events occurred outside of Wisconsin, they did hit home financially. Madison-based American Family Insurance, which has been paring staff and closing claims offices, reported a 39% drop in net income last year due to a record $1.2 billion in claims received. Most of the claims were due to weather events.

The culprit, according to the National Oceanic and Atmospheric Administration, is climate change. Under this theory, the warming of the planet creates more evaporation from the oceans, resulting in more water vapor in the atmosphere, which contributes to more frequent and violent storm activity.

Not everyone buys this, as climate change/global warming has plenty of skeptics in the scientific community and elsewhere, but the insurance industry has certainly embraced it. While it's very early in the 2010s, the percentage of premium costs associated with catastrophic losses has reached 6.7% in this young decade, and it has been growing in most decades since the 1960s. It was 1.04% in the 1960s, 0.85% in the 1970s, 1.31% in the 1980s, 3.39% in the 1990s, and 3.52% in the 2000s.

Should this pattern persist, it would impact the cost of risk. For the insurance companies assuming the risk, it impacts how they price their product and how they, in Hausmann's words, "capture those exposures." Even though mid-sized account pricing in the property-casualty line is about where it was in the third quarter of 2000, according to the Council of Insurance Agents and Brokers, a more challenging rate environment is emerging.

"Of course, nobody really cares if the insurance companies take a bath in terms of their financial performance, but this is a very tough thing to account for because for many years, although there have been some variation, it has been pretty static," Hausmann said. "Now there are standard deviations that are taking place due to the weather."

Hausmann said the cost of property insurance already is inching upward, which affects the premium rates associated with homeowners' policies and the rates of commercial developers who own office buildings. In the case of the latter, those increased costs typically are passed on to office tenants.

The 10% hit

David Montgomery, president of Independent Insurance Services, said the impact on property-casualty rates is not trivial. "The concern over weather and storms is universal," Montgomery said. "The vast majority of companies are figuring that with commercial property, they need to be seeing at least a 10% increase in premiums right now. It needs to trend that way over a period of time, and they have got to get at least in the 5% to 15% range – averaging 10%."

When those cost increases go into effect, insurance agents will have some explaining to do, especially with newer clients who might not understand the cost-sharing principle of insurance. The more experience clients have with property insurance, the more they understand the concept of spreading risk.

"The ones who haven't been around as long, it takes more time to explain," Montgomery noted. "There are clients out there where the attitude is, 'Hey, I didn't have a claim, so why should my rates go up?' We try to explain that the people who did have a claim, they are perfectly good property owners, and if they have a $100,000 property loss due to a storm, the insurance company is not going to be able to make that up from that client.

"That is the principle of insurance. Everybody has to share to a degree. The ones who experience the loss might share a little more, but everybody has to share in this."

Regarding climate change skeptics, who caution against making too much of what could be an outlying year (2011), Montgomery said it's hard to ignore recent loss history. "You can think anything you want, but it's there, it's happening, and the trends seem to be there," he said. "The insurance companies, as far as their pricing, have got to figure that this pattern is going to be what's happening. Most people accept global warming to a reasonable degree. Regardless, it [the loss history] is happening, and you can't dispute what is happening."

Tornadoes aren't the only type of storm or weather-related event that worries insurers. "When we have a tornado or windstorm, you have a pretty good idea of what that is," Montgomery explained. "Hail is the more scary one, where you could have a hailstorm and damage can be so spotty. Once a hailstorm hits, you could be seeing claims being submitted on that anywhere from the next day to a year later."

Montgomery, who has been in the insurance business since the mid 1970s, said the April 13, 2006 hailstorm that hit a large part of the state, including Madison, was the worst hailstorm he's ever seen. "That was the storm that kept giving, with people reporting claims a year to a year and a half later," he said. "From that point on, there was a year or two where it was slower, but the frequency and severity [of weather events] was especially noticeable to me starting in 2010. There was period of about a year and a half where you could not go more than three months without wind, hail, or a tornado in the area."

Based on that storm experience, in which checks routinely were written to replace people's roofs, insurance companies might be a little more cautious in paying claims. Some people who received checks to repair their roofs pocketed the money and never had the roof repaired, which could prompt insurers to not renew policies.

"In the hailstorm, the practices of companies were to walk down the block and write out checks – 'Yup, you need a new roof, here is your check' – and there were a number of people who, after they got the check, looked at the roof and said, 'You know, it isn't so bad,' then put money in the bank and never did anything with it," Montgomery said. "Then years later, hail comes again, and whoops, now we have hail damage again, they have gotten paid earlier and not done repair work.

"Hail damage can be a little fuzzier. My advice to insurance companies is that if they pay a loss on hail, they should non-renew clients who don't repair their roofs that they get paid to repair. That is not a common practice today, though."

More rate heartburn

Another line of insurance that has offered stable rates is workers' compensation, but Hausmann worries that might be about to change. For years, workers' compensation rates nationwide have been relatively stable, with little rate fluctuation or rate increases, but Hausmann wonders how long that will last if predictions of even higher medical inflation come true.

"This [rate stability] is what had happened during the last 25 years as companies embraced risk management when it came to safety," he noted. "The incident rates – the number of claims – dropped because companies understood they needed to have this kind of culture in order to be successful. But of course, you can't get below a one handicap. You are really at the point of diminishing returns when it comes to that.

"There is a feeling that the industry has, for the most part, taken all the low-hanging fruit and got it to a point where they were doing the best they could within the workers' comp process, itself. But medical inflation is just going to eat this process alive, and we will start to see trends in workers' comp rates going up."

Sign up for the free IB Update – your weekly resource for local business news, analysis, voices, and the names you need to know. Click here. If you are not already a subscriber to In Business magazine, be sure to sign up for our monthly print edition here.