Is the industry underestimating hurricane risk?
Hurricanes are rarely out of the news cycle at this time of year and 2020, with its record-setting number of US landfalling storms, is busier than most seasons. It's a year where we have cycled through the alphabet already – with normal convention being that most letters are used to name a storm - and switched to the Greek alphabet with more than a month of the season still remaining.
Yet, with all the coverage in the mainstream and trade media, there's one important issue that doesn't seem to be on anybody's mind: Why is much of the insurance industry and its models so significantly underestimating hurricane risk?
I'll try not to get too scientific or technical, but, if I do, bear with me as it's important to understand how our industry is underappreciating a risk that dominates this time of year.
The Atlantic Multidecadal Oscillation (AMO) is a pattern of natural climate variability which has a major impact on the frequency of major hurricanes in the Atlantic Ocean. The AMO is characterized by fluctuations in ocean temperature and changes phase approximately every 25-40 years. Since 1995, ocean temperatures have been warmer than average between Africa and the Eastern Caribbean, giving us the hyperactive hurricane seasons of 1995, 2004, 2005, 2008, 2010, 2017, and 2020 (to date).
For many years, the industry considered the impact of the AMO on major hurricane frequency in the Atlantic and adjusted risk views accordingly. However, for the last several years, some of the most commonly used catastrophe models have started to disregard the influence of the AMO on Atlantic hurricane activity. This is despite no forecast end of the current AMO warm phase. We know this because usually there is a tell-tale cooling off of ocean temperatures in the tropical Atlantic, and there's no evidence of this currently underway.
It's truly inexplicable that many industry players have switched to a longer-term frequency perspective while the AMO status continues to point to above average frequency of storms for some time to come.
Our role as insurers and reinsurers is ultimately to be there when bad things happen. To pay claims and help communities – whether that's households or businesses – put their lives back together following an event.
To do that we must manage the potential impact of hurricanes and hurricane-related expected losses to our portfolios, reserves and capital. If we're consistently misjudging the risk through inadequate frequency/severity views, then it's difficult to do that effectively.
As the safety net for many people who rely on us to be the helping hand that picks them up, we need to ensure we're on sound financial footing to do this. 2020 has been a year that we'll never forget for all the wrong reasons, but, if we're looking for positives, could one be that the heightened storm activity might prove to be the canary in the coalmine? Is it a forewarning of things to come and the reminder our industry needs to once again start incorporating the AMO into our risk assessments?