Earth Wind and Fire,

Readers of a certain age will recognize the title as a reference to a legendary, genre-spanning music group created in 1969. One could alternatively go back a few thousand years to the Ancient Greeks, who believed that the world was made up of 4 elements, Water, Air, Fire and Earth.

(Re)insurers have long taken earth(quake), wind(storm) and (flood)water seriously in their CAT models, but have tended regard fire as a less likely catastrophic risk, with lower PMLs. This is slightly ironic in the context of the fact that most of the original insurance companies, in the UK and the US, were established to cover fire risks, including Benjamin Franklin’s The Philadelphia Contributionship for the Insurance of Houses from Loss by Fire, founded in 1752.

All that will (or should) now have changed, as estimates for losses from the current spate of wildfires in California run to USD 19BN and are still rising- not, in itself, a threatening amount for (re)insurers’ capital, but nevertheless approaching the levels seen in the other categories. Equally disturbingly, frequency has increased as well as severity.

We are sure, therefore, that firms such a RMS, AIR and Eqecat are rushing to review and update their models, as are the modelling teams in all the major CAT (re)insurers and brokers. It will be interesting to see whether and how events affect pricing and capacity during the forthcoming 1/1 renewal period. Not only that, but it will surely cause corporate risk managers, particularly for power utilities, to re-assess the size of limits they need. After all, one only has to look at the impact of the California wildfires on PG&E’s share price and credit spreads.

So, what lessons and observations can be taken away from such events?

Firstly, that “old” risks, such as fire, that were, no doubt, thought be well understood, can still mutate and cause surprises.

Secondly, if a combination of forest management practices, changing weather patterns and human encroachment can cause such devastating outcomes as in California, which other concentrations of economic value could be vulnerable now and in the future?

Thirdly, tensions between regulators, insureds and (re)insurers are likely to increase. To cover potential losses, rates should increase, but (like flood insurance) homeowners, at least in the US, believe they have a right to build even in areas known to be vulnerable.

Fourthly, the lack of long-term data points is going to make building effective models more difficult, because no-one really knows what reasonable parameters should now be.

Fifthly, new technologies and management practices are likely to evolve to address both the risk and the opportunity.

The overarching point is that even experts can become complacent that the boundaries of certain risks are well understood and so vigilance perhaps wanes. People obsess over “emerging” risks, while overlooking the fact that long-standing assumptions are just that- and need the same periodic re-assessment as any other CAT or (re)insurance risk. Catastrophic fire risk should be a white swan amongst the grey and the black, not a surprise.

As we have said before, to survive, prosper and avoid ruin, one has constantly to re-examine, re-assess and test one’s models and assumptions. Being paranoid helps!

The Awbury Team

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