The growing threat of secondary perils and how Munich Re US can help

Marcus Winter (00:01):

Hello, and welcome to Nothing Assumed. Let's talk about key topics that keep the reinsurance industry up at night. My name is Marcus Winter, and today it is my pleasure to welcome my colleagues Mike Quigley and Tehya Duckworth. Tehya is one of our property team leads here at Munich Re US, and together with her team, she's underwriting a very broad spectrum of reinsurance treaties and has a particular focus on some of our regional US exposures. And Mike is our head of property here at Munich Re US. And in addition to property, he's also responsible for all of our pricing and for our NatCat modeling. Together, we will address the topic of secondary perils. Mike, Tehya, welcome to our podcast.

Michael Quigley (00:43):

Thanks, Marcus. Happy to be here.

Tehya Duckworth (00:44):

Thank you, Marcus. Glad I could join you both.

Marcus Winter (00:47):

Mike, can you tell us what a secondary peril is and why we, as an industry, need to talk about those?

Michael Quigley (00:54):

Sure. The insurance industry and reinsurance industry traditionally apply the term secondary perils to events such as floods, winter storms, wildfires, and severe convective storms or thunderstorms, which are often accompanied by tornadoes and or hail. These events are typically frequent in nature but individually cause minor losses for insurance companies relative to other high-profile catastrophes such as hurricanes and earthquakes. At Munich Re, we prefer to refer to such perils as non-peak, as they are not, by definition, measured in terms of small and medium-scale disasters but often have an accumulation effect over time. In fact, the 2023 loss statistics were characterized in large part by these kinds of non-peak perils. While the balance of natural disasters in 2023 was comparable to previous years, what was remarkable was that this was achieved without a single event with an insurer loss of more than $10 billion. 2023 had a record 33 events of greater than $1 billion in insurer losses, 24 of which occurred in the United States. Loss events that were previously regarded as so-called secondary events have become major loss drivers for insurers on a cumulative basis.

Marcus Winter (02:15):

Mike, storms and severe thunderstorms alone cost damage of $76 billion in 2023. That's why we focus our discussion today on severe convective storms. Can you give us some background on how often those occur?

Michael Quigley (02:29):

Sure. But let me first start by providing some context as to how and where such severe convective storms typically form in the United States. According to NOAA, three basic ingredients are required for a thunderstorm to form moisture, rising unstable air, that's air that keeps rising after a given nudge, and a lifting mechanism to provide that nudge. This often occurs over hills and mountains or along boundaries between warm and cold air masses or wet and dry air masses. These storms can form just about anywhere, but they're especially prevalent in the US, from Minnesota to Texas, where cold, dry air from Canada often meets the warm, moist air from the Gulf of Mexico. Now, to your question as to the frequency of such storms in the United States, the actual number of US tornadoes wasn't particularly remarkable in 2023 as compared to the last few years, it was only about 9% to 10% higher than the average over the previous few years.

(03:35):

There were only about half the number of EF-2 or stronger tornadoes in 2023, as there had been on average in recent years. The EF, or Enhanced Fujita Scale, is the measurement of a tornado's strength. For example, EF-2 tornadoes are those that have winds greater than 111 miles per hour. What is of note, however, is that NOAA recorded a large increase in the number of hail events producing hailstones of greater than two inches in diameter, which is more than 50% higher than in recent years. In addition, non-tornado events exceeding 75 plus miles an hour winds were more than double in recent years. This makes 2023 the year of hail and straight-line wind. What is especially troubling about that is that the US severe convective storm loss has nearly doubled in 2023 from the average of the previous two years.

Marcus Winter (04:30):

Thank you, Mike. Your statistics paint quite the picture for us. Tehya, can you tell us something about the factors that are impacting the increased losses from severe convective storms?

Tehya Duckworth (04:41):

As you know, Munich Re has been actively engaged in this space for US risks for well over a decade, even before the Tuscaloosa and Joplin events that put a spotlight on severe convective storms. So in that time, we have seen losses increase from severe convective storm for non-meteorological reasons as well as the meteorological ones like Mike mentioned. So when we look at the non-meteorological effects on severe convective storm, we can cite things like inflation, which we're all pretty familiar with this topic by now. And severe convective storm, of course, is not immune to the effects of inflation, including even localized demand surges post-event. Then we also have identified what we refer to colloquially as the bullseye effect, where the population and the housing growth in an area that's affected by a severe convective storm has increased over the last 50 years or so. So if you think about 50 years ago, there used to be a big field, big tornado comes through, no losses because there's no property to damage. Now, there's a home there, you're going to have losses.

(05:46):

Construction quality and materials, which the IBHS has been researching and finding some interesting as well as concerning things when we think about the real useful life of asphalt shingles as well as the role that garage doors play in a home causing it to succumb to a wind event. They also have research going on with siding and windows and looking at those particular materials and their impacts. And then there's also been fraud in what we refer to as legal system abuse, particularly around hail claims. And there's potentially other variables which are part of our ongoing research on this topic. So when we look forward, we would expect these factors to continue to impact losses coming from this peril, but to varying degrees. Meteorologically speaking, we've already heard from Mike about those recent past events and what made 2023 remarkable. But the big question that we have from all of our clients as we look forward is, "How do you expect climate change to impact severe convective storm?"

(06:46):

At the moment, key Munich researchers have the following projections on severe convective storms and climate change. Number one, we have a high confidence that the average and maximum rain rates associated with severe convective storms will increase in some regions globally, including the U.S. This means, of course, more flooding associated with severe storms, but it also means more opportunity for water intrusion where rain gets into the home and areas damaged by wind in the storm, and that drives up the severity of claims. Number two, we also have high confidence that CAPE, which is a measure of the potential convective energy and within a storm, we hear of it often referred to in the tropical storm space, that we have high confidence that CAPE will increase with global warming in the tropics and the subtropics, which suggests more favorable environments for severe convective storm. And that translates to a potential increase in the frequency and especially the intensity of the storms that form in those regions.

(07:47):

And then third, specifically for the US, we have a medium confidence that the frequency of springtime severe convective storms will increase in the US, leading to a lengthening of the severe convective storm season.

Marcus Winter (07:59):

So with all these different factors that Mike and you have now mentioned to, Tehya, can you tell us what this means from a practicality standpoint for our insurance company clients?

Tehya Duckworth (08:11):

Yeah, sure. The reality is that severe convective storms impact every part of the value chain for our clients. So, for example, if we look at their underwriting, they need to have clearly defined appetite and design their criteria around the peril. So that's going to include things like the age of the roof or the type and condition of the exterior, including roof siding and windows, like the IBHS is researching. They've got to consider deductibles and co-insurance options, replacement cost eligibility, how to handle cosmetic damage from hail, and what risks to inspect. And the criteria for re-inspection, be it a renewal or post-claim after there's been work completed. In their rating systems, they need to tailor the variables and the risk classifications according to the dynamics of the peril to consider things like mitigation and resilience. Is the roof deck sealed? That might go a long way to reduce claims costs with increased precipitation in the climate forecast.

(09:12):

Considering the surface area of the roof and how it relates to the overall value of the insured property is also important. Looking at the siding and roofing materials and your rating variables, not just your underwriting criteria. And then, like tropical cyclone, the shape of the roof matters when we're talking about severe convective storm too. When you look at pricing, we can look at the reported poor results of carriers who've been impacted by these storms and the magnitude of then the subsequent rate impacts or the rate filings that they're taking. And it appears that this peril has been largely underpriced in the market, possibly because of optimism bias, which can always explain the battle way or possibly over-reliance on models that aren't well understood or don't fit the risk profile well. Clients really need to understand the relationship in their own portfolio to the industry portfolio used by the models.

(10:03):

So a client's risk appetite might be broader or stricter than the industry, which is going to have an impact on the results of those models, and they're fit for use for their portfolio. And sometimes we see that with portfolios that might be actual cash value versus having a broader risk appetite, and then can cause some things make it better, some things make it worse, and you're not sure when you put it together which way it's going to end up. All these variables and model calibrations would then require comprehensive and reliable data inputs, which means investing in systems and tools to gather, store, and analyze the data. Third-party data can help, but clients also need to thoroughly vet that data, as it can be incomplete or unknown for many key variables. They also have to think about accumulation management, but not just for a single large event like you would for hurricanes or earthquakes, although there have been these single large events like Tuscaloosa and Joplin.

(10:57):

But the bigger paint for severe convective storm comes from the aggregation of many events, the death by a thousand paper cuts, if you will, and that requires a different approach to accumulation in capital management than most clients have employed. We often think that diversification is king, but you have to be careful with these frequency perils that you keep an eye on the aggregate loss distributions, especially with something with severe convective storm, which can traverse the entire country, and mindful also of potential correlations with other perils like hurricane because both can tend to be worse during La Niña phases of the ENSO cycle.

Marcus Winter (11:37):

And is there anything that the insurance companies can do with their clients?

Tehya Duckworth (11:37):

Sure. When it comes to distribution, especially, clients can educate their agents and their policyholders on the dynamics of the peril and how to respond to an event. There's often misinformation spread, which can actually contribute to a loss instead of avoiding one. So the best example I can provide is when I moved to the Midwest over 30 years ago. It was commonly believed that if you opened a window during a thunderstorm, just a bit of a crack, you could actually save your home from a tornado because it was believed to relieve the pressure differential between inside and outside. But in reality, that's the worst possible thing you could do. It's akin to opening a window on an airplane at 30,000 feet. However, this myth was still prevalent when I moved away from the Midwest 30 years later, so this was just two years ago.

(12:25):

So it's still pretty prevalent today, and there's still a lot that clients can do in the claims side as well to educate policy holders and to train their claims team to understand this peril, especially hail, and be able to identify potential fraud in attempts to enrich the policyholder beyond the terms of the contract. So educating them on the terms of the contract would be really key, and having the claims be a part of that process.

(12:50):

And additionally, your claims teams can use tools such as aerial imagery and meteorological reports that can facilitate the claims triage process, which would lead to a smoother and more efficient settlement process for both client and the policyholder. And all of these things, of course, within the context of each state's regulatory environment, these things can be challenging and expensive for a client to implement. They sometimes can be viewed as being impediments to expense management, competitiveness, and ease of doing business. But as we've seen with this peril lately, the risk of not executing well in these areas for severe convective storm means not just reduced earnings but reduced capital, which ultimately becomes unsustainable.

Marcus Winter (13:29):

Thank you, Tehya. That really is a long list of things that the insurance companies can do. Mike, is there anything that we from Munich Re US, have an offer for our clients to cope with those severe convective storms?

Michael Quigley (13:44):

Yeah. First and foremost, Marcus Munich Re US can help by sharing our expertise. You just heard Tehya and her wealth of information and knowledge on this peril. We are seeing these aggregate losses continue to climb and impact our clients and their balance sheets. So we're at the ready to provide that insight. Munich Re has developed proprietary risk scoring tools that provide users with a view of location specific exposures to various natural perils, like severe convective storms. Our internal modeling of the severe convective storms accounts for these views, including variation in hazard model and building vulnerabilities, a lot of the components that Tehya had outlined in the various regions of the US. So we continually adapt our views and models with the updated science and observations from recent claims activity and are ready to share those insights with our clients to help to navigate the shifting risk landscape.

Marcus Winter (14:42):

Tehya and Mike, thank you very much for sharing your thoughts and your insights. Here's my last question that I ask all of my guests. If you had a magic wand, what would you change about convective storms?

Michael Quigley (14:56):

Okay, Marcus, if I could change anything from a practical industry angle, I would like to see more of a focus on adequate building codes and practices as well as code enforcement across the country. There's been quite a bit of focus on that in the hurricane-exposed states and in the Southeast, but really, where we see these severe convective storms impacting the most is in the center part of the country. And we really need to improve the building practices and enforcement touch that we can mitigate the impacts of these storms. As an industry and society, we need to be focusing more on the resiliency of our communities and on loss mitigation. Otherwise, we find ourselves in an insurance affordability and availability crisis.

Marcus Winter (15:43):

That's a very good point. Tehya, what's the one thing that you would change?

Tehya Duckworth (15:44):

Great question. Mike really hit the nail on the head. I would just add to what he said that having clients and their policyholders function more as transparent partners in both mitigation and in damage assessments, remembering that we are all in this together, working to strengthen the resilience of our communities both prior to and following an event.

Marcus Winter (16:03):

Tehya and Mike, thanks for being here. And stay tuned for our next episode. Bye for now and see you next time on Nothing Assumed.