The Insurable Apocalypse

Catastrophe losses and the insurance industry's role in climate change.

Photo by ArtHouse Studio from Pexels

Claire’s Diary: November, 2018

If these walls could talk, they’d tell you my life story, my family history. If I had the strength to think of a happy memory, it would have probably been through those windows. Thank god everyone is okay… but how many more times until a last-minute evacuation turns into our last minute?

If I wish, my insurance company will rebuild out of the rubble but they seem to want me to take the money and move.

Should I leave my hometown like the ash of my neighborhood, vertiginously West with the Santa Ana Winds?

Is it too prudent to give my family a fresh start in the East?

Claire is a work of fiction but her story is not. The truth is, more Californian families are making similar decisions every year. Not-so-coincidentally, insurance carriers are wrestling with that same decision on a macro-level.

What We’re Seeing With the California P&C Market

California, 2018, the deadliest wildfire season in its history. Swaths of counties were deserted by their insurance providers. So much so, that the Department of Insurance issued a Mandatory One Year Moratorium on Non-Renewals. Holding carriers hostage until a deal could be made.

By 2020 the state started allowing individual rate increases (the percentage amount varied by carrier), in an attempt to appease an industry desperately clinging for an optimal price-point. Many believe the market is balancing againand are heading back to CA with 200% markups and some good old-fashioned short-term memory.

It’s a state that you wish you could forfeit but you can’t afford to; workers comp rates looking for the floor, while P&C is reaching for the ceiling. As an old, noble poet once wrote once said:Yeah, Hollywood is bleeding, but we call it home.

But the whole world is bleeding….and Elon isn’t likely to invite you to mars when shit hits the fan (without a price).

Duct-tape The Ship

As the world changes so does propriety.

“250-year” disasters are morphing into 50-year cycles. So how is the insurance industry able to cope with this trend of severity? What are the new accepted standards?

Reinsurance. → the person who covers people… whom cover other people.

How has this subsection of the industry, that specifically handles disasters and massive lawsuits been doing lately?

Well, the Reinsurance Association of America’s latest data shows what you’d expect. Increased net premiums due to significant rate hikes and combined ratios that no one would envy.

Allot of insurance professionals seem to be running on autopilot. “Just gotta get the right rate” or “That’s what reinsurance is for” are common phrases. Some companies don’t even include their CAT losses in their earnings calls. In a game of risk transference, as long as these losses are hidden from the balance sheet or being paid by another company, then it’s not a concern.

My question is, with average combined-ratios over 100%, how long until liquidity is a problem for reinsurers?

It’s no different than the issues we face for home-owners, small-commercial and middle market. Right?

For example:

If we keep raising rates on the same towns that are burning to the ground, who will be left with money to pay the premium?

It’s a delicate balance that I’d assume feeds into the reinsurance market too. Their rates directly affect commercial carrier profitability. Once we reach an inflection point where reinsurance isn’t financially viable, demand is going to plummet. Or we may just see reinsurers stretch themselves too thin to handle the next “250 year” cluster of disasters.

Lowering the demand for reinsurance will ultimately affect profitability and liquidity for the broader industry. Everyone will be forced to either flea the market, go high-end specialty, or go bankrupt. This will make things even worse for property owners in areas like California. Who will again, feel the brunt of insurers fleeing their counties.

Away With The Status Quo

Here’s a quick list of some typical solutions our industry favors and the likely outcomes when it comes to Catastrophe claims. All points reflect my opinion and are open for debate.

1. Raising Rates & Limiting Appetite.

We’ve seen CAT-prone geography expand each year, which likens to diminishing growth potential for carriers unable to provide them products. An industry cannot rely on rate increases alone for growth, especially when they’re based on out-of-date, historical modeling. Eventually rising premiums will result in a negative economic impact to dozens of US regions, many of which being low-income or rural areas.

Will these small economies be able to brace for the brunt of exorbitant premiums as disasters hit? No, not unless at-risk economies and their infrastructure are resilient enough to afford the upward price pressure required to keep covering these homes and businesses profitably.

We need to be careful how we look at these decisions in areas like California. If customers suddenly can’t afford their insurance, they can start to lose business, property and contracts that keep their families fed. We’re in the business to pay losses and make profit but we have a responsibility not to do wide-scale financial damage to the customer-base that need our protection the most.

Then there’s the bad apple problem that will grow as the wealthy are the only ones left who can afford growing rates. While climate change exasperates our loss ratios, “people are also putting more valuable houses, offices, and infrastructure in threatened regions, increasing the toll when a major disruptive event does occur” further magnifying our payouts.

2. Tax funded claims.

The government has a history of relieving the insurance industry of responsibility for catastrophic losses they are unable to cope with. But how successful have they been? And given its history, can we really count on this option today?

• Medicare, Medicaid and ACA were examples of this. This broad stroke of artificial demand and regulations has done a number on our healthcare costsand is still a major economic and political debate to this day.

• Flood insurance is costing taxpayers billions and most Americans don’t know they need it, or can’t afford it. Once our flood zones are made on higher accuracy predictive modeling, the government is going to have its hands full with all its new customers and hemorrhage billions every year until it’s unaffordable by the public. FEMA is 20B in debt and currently using premiums to pay interest. The balance sheet, lack of a healthy risk pool and poor flood zone modeling are deep rooted issues for this federal program. FEMA recently announced updated rates, but will that be enough to stop the ship from sinking?

• Terrorism coverage was meant to be a temporary, public-private partnership but has been approved for multiple extensions as recent as 2019. It will ultimately fall back on the private sector once we have more data to properly rate for large-scale terrorist attacks. This is not a good example as it was never intended to be permanent and thankfully, hasn’t been properly tested.

In general, when the government takes on too much risk in our industry, it helps in the short-term, but it does so inefficiently, rigidly and brings with it the moral hazard to continue repeating mistakes. Insurance is a major economic driver through it’s ability to offer expedited loss recovery, but when it’s funded by tax-payer dollars, running in the negative year over year, it won’t offer the same net positive effects. I’m not stating it can’t be done correctly, I’m saying that it won’t be.

3. Regulation:

Forcing coverage for exposures that have not been properly rated for, leads to corporate losses and withdrawal once a moratorium ends. Since the pandemic, it’s been increasingly popular to expect insurance carriers to pay for large-scale losses. As a temporary solution, moratoriums do not force specific coverages or backdated claim payouts, which is good. Though they still have a negative affect on the industries bottom line and can make it more difficult for us to return to an area once the moratorium has ended. It’s not easy to come up with profitable rates for a territory when you’re forced to hemorrhage losses there for a year or longer.

If we talk long-term, large-scale policies, it gets much worse. If the government started directing what losses should be covered and where, or stopped carriers from leaving territories for an unspecified amount of time, politicians would be creating a problem that “only the government could solve”. It’s actually very easy to do this to an industry without malice. If you’re in the state legislator and you watch constituents lose their homes to a disaster, with no insurance payouts, how would you feel? Personally, I would want to do everything I could to get retribution for them and the first thing I might do is enact bills that force companies to either stay or pay.

But what happens next?

As companies follow the new regulations, they continue to operate at a loss and bankruptcies, mergers and acquisitions ensue. Eventually the insurance industry in this particular area becomes so illiquid that the public demands the government takes it over. The government will make it a public commodity but will not have the right spread of risk or historical rating information to run it at a profit. They will need to ask for federal funds to keep it running at a loss and that will ultimately have a significant impact on the economy.

We need to be careful of good intentioned policy makers just as much as bad actors and make sure we recognize when someone is creating a problem just to become the solution. Moratoriums themselves can have their benefits when it comes to bargaining power. They can get the major players to the table for negotiations, but it is not an effective solution in and of itself and can be a slippery slope.

Summing it up:

Therein lies the dilemma we continue to face: “Providing insurance for properties facing climate disasters can create moral hazard, a situation where people are less inclined to adequately prepare for a disaster because they are insulated from the consequences. Yet dropping coverage or pricing people out of policies leaves them in the lurch when disaster strikes.”

Here are some ways I think we can sidestep the rock and the hard place…

How We Can Save The World And Our Bottom Line

1. Investments in biological R&D.

For example:

• Wildfires are typically preceded by ground moisture and biomass abnormality.

• There are techniques we can study in the agricultural industry on balancing the moisture in a given plot of land

• Investments in this area, once scaled, can help protect your book of business from wildfires.

This is just one, possibly far off example for what I believe to be a reasonable consideration. That carriers are well suited to push the boundaries of science and may benefit from investing In more assets than just stocks, bonds and real estate.

Taking ESGs to the next level, investments in sustainable and renewable technology could also be used as insurance pilots for new business growth. Investing in any industry requires data and research, both of which the insurance industry is well positioned to expand. In other words, if you can invest in it, you can underwrite it. It will also give carriers more incentive to protect these businesses from P&C losses if they have more of a stake in these industries than premium flow alone. Think of it like an agency captive. If you have minority investments in the same industries that you’re writing insurance products for, then you’ll have a stake in their success or failure. This should incentivize carriers to take an innovative approach to underwriting and risk-engineering that will benefit all parties.

Essentially, environmental and technological investments will turn a B2C relationship into a partnership to protect the insured’s business and plan for contingencies together. Similar to the Loss-Control surveys we have today, but focused, modernized and vertically integrated for specific emerging threats.

2. Private/Public Partnerships

The fight against a systemic risk requires collaboration on a scale that our industry is already accustomed to (lobbying, zoning, fire safety, preventative policies, risk modeling). We have the tools and experience to influence the system. So let’s continue to do so with a more targeted approach: by offering our tools, resources and coverage to municipalities that are willing to divert funds towards civil and economic investment that would best prevent climate induced disasters. This will allow greater opportunities for novel products like parametric insurance and municipality financing.

It can be treated as a pilot program at first before it’s offered at-scale. This program should also be looked at as a partnership, where the carrier becomes a consultant and benefits from the preventative measures and economic stimulus the municipalities pass.

3. Reducing capital investment and risk appetite for heavy polluting sectors.

This is actually something that’s already being done, but mostly in Europe. Responsible investing, carbon neutral investing, they’ve all become quite popular over the years. Many companies invest in green industries to offset their own annual emissions. The insurance industry is no outlier here but they can do more and be handsomely rewarded for it by offering transition risks and allowing more leniency to SBOs.

Slowing or ceasing investment/coverage in declining industries can be a powerful tool, particularly when we’re talking about middle market and national account business. My main recommendation to add on to that would be to offer tailored coverage to the businesses that can afford to transition to greener processes. Most large carriers are offering green upgrade endorsements, but honestly, that’s more of a PR coverage with no significant effect to the environment. Now a transitory risk product? That would make an impact and we can justify high rates on an exposure like that.

There’s more that can be offered and more ways we can persuade business owners to make proactive changes to their property and business models. For example, what would happen if a grocery store was able to get off the electrical grid? If the grocery store had its own renewable energy, with batteries being stored for emergencies, they’d mitigate the losses that affect them the most. My guess is that BI and spoilage losses would be less frequent and severe.

Even on a smaller scale we can make a difference and save money. If that same grocery store was claiming spoilage losses every year due to an old refrigeration unit that seems to breakdown every 6 months after a repair. If their insurance company refrained from threatening them with pricing or Non-renewal, but enticed them to replace that unit for a premium discount or equitable financing, wouldn’t that be a better deal for everyone?

The main point I’m trying to get across is this: Disinvestments should be a starting point, a first step, not the whole solution.

4. AI, API, Predictive modeling to takeover.

Based on personal experience, this is already being done and is a topic deserving of its own article. With predictive modeling being one of the most interesting part. It’s shocking to me that an industry that has been built on statistics for centuries, is not at the forefront of big-data capabilities.

5. Inspiring talent

We protect people from going homeless and we protect businesses from going under. We help contractors start their next project and consultants win their contracts. We sift bad-actors out of the economy and keep the good ones out of the courtroom.

And we do it all while making a profit…

We need to start taking these achievements to heart, getting excited and taking our responsibilities seriously. Insurance isn’t just the financial backup plan for a business or a household. It’s also the finance back-up plan, where no undergrad dreams of landing their career. There’s allot that needs to be done to recruit a passionate workforce and I have plenty of ideas that can get us there.

First and foremost, you need to spark passion to compete in this generation and it needs to start with the mission. What better mission to Millenials and Gen Z than this?

“Were going to divert the world from an apocalypse, then rebuild the areas we couldn’t save and we need you to help us figure out how”.

Conclusion

We need to embrace how vital we are to moving the world forward. If we don’t believe it, or at least work towards it, then we’ll never be able to sell this job to the caliber of recruits that we need to tackle the future of insurance. This industry is conservative and risk-averse (at-least admitted carriers). It tends to appreciate patience, put value on boring and pass the same risks back and forth endlessly between each-other for the sake of new business premium.

Well, what if there was a global risk that was unavoidable? If that were the case then wouldn’t you would want to plan and pilot new models and be the first to do so? Data and loss history are kings in this business and you’d want to have that data and experience to build a competitive mote around you. You can test new markets and products without hurting your financial outlook. Paraphrasing Jim Collins and his transformational book on corporate success “Shoot the marble before the cannonball”.

Catastrophe risks are real and unavoidable. The time for this industry to take responsibility and embrace innovation was yesterday. This existential crises can and will have major carriers looking for bailouts from the tax-payers after waiting too long to pivot. Yesterday is not ours to recover anymore, but tomorrow is ours to win or lose.

So let’s start sending probes out into the future, figuring out new appetites and new investments that can also double as risk protection for your current book. Let’s start opening up our business model to evolve into partnerships with our customers and municipalities, with symbiotic relationships in mind. Investing in our technology, customers, employees and messaging, before too much of our capital needs to go towards hurricanes and fires.

We have a difficult road ahead of us with an aging workforce. If we’re going to save the world from economic collapse we need smart, creative and passionate people making decisions and we need to allow them the freedom to do so in a modern, flexible workplace.

When it comes to natural disasters and pollution, individual citizens can’t do anything to tip the scale in a significant way. Our government in the US is stuck in a constant pendulum swinging from one rhetorical extreme to the next, all the while making minimal and insufficient progress. The insurance industry has the power to push the economy towards a better world. We can clean up our backyards, region by region, parter with local governments and incentivize them. We can inspire the world of finance with cutting edge, equitable and profitable service offerings.

The new age of labor is now. The ushering in of the Great Resignation and r/antiwork is not a fad. We don’t want to make a living anymore, we want our living to make a difference. The insurance industry is at an inflection point with two choices ahead: either hold onto an ancient system and end this century in bankruptcy, or bring in fresh eyes and calculated idealism into the boardroom. It’s a choice between global catastrophe and a historic feat of human ingenuity and it’s our choice to make.