Insurers have seen an increase in catastrophe losses over the past several years, despite a relatively benign 2013. Underwriters and their policyholders need to take a proactive approach to managing catastrophe risks as they address the increased exposures, says Roderick Hudson, a regional underwriting manager at Markel Corp.

One year after Superstorm Sandy, one of the mildest hurricane seasons on record has come to a close.

But Typhoon Haiyan, one of the most powerful storms ever recorded; the severe storm widely known as Christian that hit northern Europe in late October; and the November outbreak of severe tornadoes that ravaged the Midwest served as devastating reminders that insurers should not lapse into a false sense of security in the lack of U.S. hurricane activity.

Catastrophes are global in dimension, can occur at any time and are able to severely and immediately hurt an insurer's bottom line.

Scientific research and data point to changing climactic conditions (global warming) as the primary cause of increased heat waves, droughts, flood and storms with strong winds and hail that cause significant damage.

Events such as thunderstorms and tornadoes, which often follow thunderstorms, have been the most frequent types of catastrophes in the United States in recent years.

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In fact, a hurricane greater than Category 1 has not made landfall in the U.S. since 2010. And prior to Sandy, thunderstorm losses outpaced hurricane and tropical storm events $60 billion to $20 billion during 2010 through 2012, according to the National Oceanic and Atmospheric Administration. Current industry estimates place average annual losses at $25 billion for catastrophes in the United States.

Exposure to catastrophes has become more severe worldwide because of the consistent growth of population and building values in high-risk areas. For example, in addition to much-sought-after locations in coastal areas, formerly rural areas of states in the South and Central Plains regions of the United States have experienced dramatic growth in population and insured values. These areas are prone to frequent and intense storm and tornado activity.

In fact, the tornado season of this past spring saw severe tornado activity in Kansas, Texas and Oklahoma, with Oklahoma alone suffering billions of dollars in insured losses resulting from tornadoes, according to the Federal Emergency Management Agency.

Poor planning and inadequate building standards in new areas of growth and development also help increase exposure to catastrophes.

Although catastrophes of all types have occurred on large scale, earthquakes have dominated insured catastrophe losses on a global basis in recent years. Events such as the 2010 Chilean, 2010 New Zealand and 2011 Japanese earthquakes caused several billions of dollars in insured losses, with the Japan event ending up as one of the costliest events in history, according to industry estimates. Overall, catastrophe losses are now averaging $25 billion annually on a global basis, according to NOAA.

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The catastrophe risk landscape consists of varying degrees of hazards and loss potential based on the geographies of the world. Insurers must execute underwriting strategies based on regional exposures and activity to optimize viable risk opportunities that best match up with growth objectives and enhance profitability.

Risk modeling is at the center of catastrophe portfolio management, and all insurers have modeling systems to help assess catastrophe underwriting. But risk models cannot provide answers, and insurers should not rely on catastrophe models alone to develop pricing and risk management decisions. Risk models provide dollar loss estimates that capture past experience of known perils against current exposures; but the future will not necessarily follow the past, which makes loss estimates uncertain.

The increased frequency of extreme weather events further disrupts the premise that the future will line up with the past. And the random nature of catastrophes creates a wide range of variables and factors in actual loss compared with estimated loss for a given catastrophe.

No matter how sophisticated the models used, they cannot predict when a loss will occur or what the traits and characteristics of a loss will be when one does occur.

The earthquakes in Chile and New Zealand are two of the more costly examples of risk model uncertainties. Model loss estimates badly missed the mark because of aftershocks and liquefaction damage that earthquake model templates did not account for. In both events, many structures that withstood the earthquakes had to be demolished because of the settlement of the structures caused by liquefaction. As a result, actual insured losses far exceeded risk model loss expectancies for each event.

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Although some insurers have seen catastrophe losses significantly reduce profitability in 2013, claims-paying capacity is at record levels, and there is no shortage of capacity for catastrophe coverage in the marketplace, according to industry analysts. However, insurers cannot continue to absorb devastating losses at the increasing frequency and severity of catastrophe events. The accelerated pace and complexity of losses means risk managers must change how they think about catastrophe risk to mitigate the consequences of future disasters.

Risks that have moderate to heavy catastrophe exposure or require high catastrophe limits, particularly those that involve the global property marketplace, will be affected most. Policyholders can help control costs and improve risk management by identifying and reducing as much exposure to loss as possible to make their risk more attractive to insurers. This includes having a comprehensive disaster preparedness plan in place and the ability to carry it out to help protect property and resume operations as quickly as possible in the event of disaster.

Policyholders can also opt to retain more exposure by selecting less coverage and lower limits to help offset insurer pricing they may find unattractive. Ultimately, insureds must determine coverage and limits needed and premiums they are willing to pay that best match up with their risk management needs.

Uncertain risk modeling and often-outdated and/or inaccurate information, such as has been discovered to be the case with FEMA flood maps after some loss events, add to the challenges faced by insurers. In addition, changing demographics, improving economic conditions and volatile weather patterns that cause events such as wildfires, tornadoes and powerful winter storms to be more common, will continue to help increase catastrophe losses and present significant threats to insurers' bottom lines.

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And business income coverages, particularly contingent business income, continue to pose significant challenges to insurers. The Japanese earthquake of 2011 and the Thailand flooding of 2011 underscored how difficult to underwrite this coverage is because of the multiple levels of interdependencies between supply chains in today's global economic environment. This is especially true for large manufacturing risks that usually have many suppliers who often are located in high hazard catastrophe exposed regions.

About 1,000 electronic component manufacturing factories were affected by the flooding in Thailand, according to Reuters. This disrupted the supply chain for various manufacturing operations all over the world, causing billions of dollars in losses as a result of contingent business income.

Insurers can restrict coverage, use reinsurance and closely monitor catastrophe exposure concentrations to help control and manage catastrophe risk.

After each disaster, the focus by insurers and others is usually on “getting back to normal.” As a result, insurers' underwriting decisions too often are guided by “rearview mirror” observations that cause pricing and risk management decisions to lag behind loss experience.

But catastrophes are no longer low-probability events. Insurers should not wait until reaching a tipping point before addressing the various emerging threats posed by catastrophes, and they should not solely rely on risk model estimates to make underwriting decisions.

Insurers must weigh other risk factors and variables and involve sound underwriting judgment to balance risk model information when making underwriting decisions and managing catastrophe risk.

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Otherwise they run the risk of jeopardizing their financial health by underestimating their true loss potential from catastrophes. Insurers that take a proactive and comprehensive approach to catastrophe risk management will be better positioned to achieve profitability in the face of the new normal of frequent and severe catastrophes.

Roderick Hudson Is a Chicago-based regional underwriting manager at Markel Corp. He can be reached at 312-258-3378 and rhudson@markelcorp.com.