Insurance Companies Eye Impact of Disasters

Scott Simon speaks with chief economist of the Insurance Information Institute, Robert Hartwig, about how insurance companies calculate risk, taking things like weather trends and global warming into account.

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SCOTT SIMON, host:

Whether this recent streak of potent storms and the warm Gulf water that fuels them are a result of global warming or not has long been a question that scientists have asked. But now actuarial science is taking up the debate. Robert Hartwig is chief economist of the Insurance Information Institute, and he joins us from our studios in New York.

Thanks very much for being with us, Mr. Hartwig.

Mr. ROBERT HARTWIG (Chief Economist, Insurance Information Institute): Very happy to be here.

SIMON: Are insurance companies going to be less willing to underwrite the insurance costs of reconstruction projects along the Gulf? Do insurance companies see more storms happening?

Mr. HARTWIG: Well, our data show that natural disasters are occurring worldwide, not just in the United States, but, in fact, worldwide, with greater frequency. In part, that's the result of natural phenomena. For instance, we know that there is a natural 30- to 40-year cycle in tropical cyclone activity that's documented all the way back to the 17th century, and we believe that we're currently about 10 years into that and it's probably got 20 to 30 more years to run. Longer term, you have issues such as global warming, which are new, more difficult to measure, and obviously in some quarters are still controversial.

SIMON: As you note, that sort of thing is difficult to measure, but it strikes me that insurance companies have to make the commitment now. They have to make some measurements now. So what kind of measurements are you making?

Mr. HARTWIG: Well, certainly, insurers do, and we look at long-term trends in disaster losses, and that trend is upward, and so in order to be able to accommodate that, what we see is a global expansion in insurance and reinsurance capacity--in other words, the capital that's available to underwrite disaster-related results. We've also innovated, in the wake of Hurricane Andrew and other disasters, the securitization of disaster risk where actually bonds are floated that tap capital directly from the capital markets and investors actually are taking a bet on whether or not a major disaster is going to occur.

SIMON: How's that work?

Mr. HARTWIG: Basically, what happens is, is insurers will sell policies in disaster-prone areas. They cobble these policies together, look at how much can be potentially lost, and then basically what they do is they go out and they sell this risk to potential investors in the form of bonds. And what happens is if it turns out that there isn't much natural disaster risk, they get the proceeds from those policies. If it turns out there were--there was quite a bit in terms of natural disaster, what winds up happening is they wind up losing their investment or part of that investment.

SIMON: You say the people in the insurance industry see an increase in natural disasters all around the world and understand this to be at the very least part of a cycle that reoccurs every 30 to 40 years. What about the--what seems to be the increasing intensity of those storms and weather because there are people who would suggest that's because the water is measurably warmer and warmer water makes for a fiercer storm.

Mr. HARTWIG: That is, in fact, part of the 30- to 40-year cycle we see for tropical cyclone activity. It has to do, again, with global water temperatures as a big part of that. And, obviously, we're expecting this to continue for the next several years. What's difficult to tell, however, will global water temperatures remain higher, not just in the Atlantic basin but in the Pacific and elsewhere, perhaps, year-round? And that may be, perhaps, the result of global warming. What that does is give an earlier start to the hurricane season as well as extending the season beyond its normal November 30th expiration date.

SIMON: Mr. Hartwig, the economic losses are so great. If I might ask you this bluntly: Are homeowners in Omaha, Nebraska, going to have to pay higher insurance rates to cover the losses of people in Mississippi, Louisiana and Texas?

Mr. HARTWIG: Generally speaking, the answer to that is no, however, the losses have been so large from Katrina, and potentially also from Rita, that there is a--somewhat of a spillover in a number of ways. All insurers buy what is known as reinsurance, which is an insurance for insurance companies. And to the extent that that pool of capital is at least temporarily depleted and that there is an increase in demand for reinsurance globally, this pushes up the price, particularly in disaster-prone areas, but there can be a spillover effect. Secondarily, we can see that the cost of building supplies, from framing lumber and plywood, to roofing materials, to labor, is all going to rise in the wake of Katrina. In fact, it actually has already. And so even if a home were destroyed or burned down in Oklahoma or North Dakota, the cost of rebuilding that house is going to be somewhat higher simply because the price of materials for materials such as lumber is set on a national scale. It's not set locally.

SIMON: Robert Hartwig, who's chief economist of the Insurance Information Institute, thank you very much.

Mr. HARTWIG: Thank you.

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