Celent’s Light: Hurricane Andrew the P&C Industry’s First Black Swan

The storm had a transformational effect on the industry and the public, but some of the lessons of Andrew may remain unlearned.

Back in 1992, few insurers had even heard of statistical “black swans” a term popularized by Nicholas Nassim Taleb in his 2004 book “Fooled by Randomness.” However, Donald Light, director of Celent’s Americas Property/Casualty Practice, notes that whether people knew the term or not, Hurricane Andrew changed they way the industry looks at extreme and unusual events.

“Back then no one knew black swans existed, let alone that they were something to incorporate into risk models and enterprise risk management systems,” Light observes. “For that matter, back then, risk models and enterprise risk management systems, as we define and use them today, did not exist either.”

Since Andrew, black swans have winged-in with some regularity, Light quips. “So frequently, in fact, that a prudent swan-observer would say ‘You know, swans come in a lot different colors, and we better start understanding what that means for our business.’” A succession of unusual events, including Hurricane Katrina and a diverse menu of loss-costing catastrophes in 2011, have led to notable adaptations in both the direct and reinsurance realms, Light relates.

“Primary insurers are creating pricing and underwriting models that rely on much more sophisticating pricing algorithms, coverage restrictions, and limits on geographic concentration, including the use of external cat [catastrophe] models,” Light reports. “They are also developing cat team capabilities that can swarm to major disasters and are much less depend on local infrastructure that might be unavailable for an extended period.”

Reinsurers have had to learn to deal with greater volatility, one of the results of which is that the industry is seeing period waves of capital infusion, creating new companies and expanding market capacity, Light relates.

Hurricane Andrew left an impact on the public too, in both the consumer and political dimensions, according to Light. For example, he says, “people are paying more for less coverage — which is painful — but in the long run is the only way to have a sustainable private insurance sector.”

While clearly some lessons have been learned from Andrew, including not only how the insurance does business but even how Floridians build homes and other structures. As I&T’s Kathy Burger reports in “5 Reasons Why Hurricane Andrew Still Matters,” some experts contend that the most significant Hurricane Andrew has had on the insurance industry and other businesses was the creation of a statewide building code system in Florida. According to the Tampa Bay Times, Florida now regulates the inspection and enforcement of building codes and requires training and licensing for building officials and contractors, and also requires continuing education.

Some lessons are harder to learn than others, however, Celent’s Light suggests. Individuals and institutions are disinclined to accept the possibility of events they find hard to imagine, he asserts. That tendency may influence how well prepared our society is to face another rare large — for example, landfall of a major hurricane further up the East Coast.

“The ability to model such events exists,” says Light. “However, the costs versus benefits of restricting underwriting and buying reinsurance for such events for extended periods for such super-low-frequency and super-high-severity events are hard to justify when the planning horizon is 12 months or less.”

[For more of I&T's coverage of the 20th anniversary of Hurricane Andrew, see Learning the Lessons of Hurricane Andrew.]

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio