Tuesday, December 17, 2013

Florida's Hurricane Risk is Overdetermined

The above images shows Wordles or word clouds of the first authors listed in the Meteorological references section of individual modeling groups submissions to the FCHLPM under 2011 standards.  You can find the same sort of word clouds for 2009 standards here.

Unique mixtures of science result in different hypothetical storms resulting in different hypothetical interactions with society.  

The above graph shows the differences in the radius of maximum winds between modeling groups.  The radius of maximum winds (denoted as Rmax) is a measure of the distance from the center of a hurricane to its maximum winds.  The mathematical derivation of Rmax depends upon central pressure.  Central pressure is calculated differently by company and judged reasonable by  respective company... often by the same statistical metrics.  

The graph depicts the range between a company's minimum Rmax and maximum Rmax for a given central pressure (CP). The difference is indexed to the average of the ranges for all companies for a given central pressure.  So, for example, at a central pressure of 920 mb, storms created by EQECAT have an Rmax anywhere from 4 miles to 62 miles (see data below), a range of 58 miles.  The average range for all the models at 920 mb is 35.42.  So, EQECAT's Rmax range is 60% greater than the average range at 920mb of all companies.  
Rmax values submitted to FCHLPM (All distances in Miles)
No matter.  The FCHLPM considers all of these accurate and reliable.  So too, the output.  

The table above shows the uncertainty interval of each company's 100 PML and 250 PML.  Given the exposure data, EQECAT estimates a 1% annual chance of a loss of within the range of $35B and $104B.  They have a 95% statistical confidence about this.  

Yet under 2009 standards and the same data set they had 95% confidence that the loss would fall between $21B and $122B. You can see 2009 standards data in the below table (I make no adjustments for inflation).  You can see this type of variation for any of the companies- I'm just using EQECAT as an example.

All of the data here is considered accurate, reliable and my favorite "reasonable."  Consider further that outside of Florida, insurers and others use totally different numbers and catalogs that they find to be accurate, reliable and reasonable. 

So my point here is that the risk is overdetermined.  This means that there are more scientific reasons and acceptable estimates than observations needed for determining the scientific quality of risk estimates.  

Given the substantial variation in accurate estimates of risk, the right or best estimate is determined by external factors such as, market and political conditions. Determining hurricane risk is, as this analysis shows, well suited for negotiation.  

Wednesday, November 13, 2013

Political Differences Between the Citizens PIC and NFIP


When Florida Governor Rick Scott ran for office he promised to push Citizens Property Insurance Corporation's rates the an 'actuarially sound' level.   And in recent times, those rates are increasing (though, this has less to do with Scott and more to do with current market dynamics).  Yet, when it comes to federal flood insurance Scott sounds more like a struggling Florida homeowner than the private market insurance advocate he is known to be.  

Recently, Scott and the Attorney General Pam Bondi, together with the Alabama Governor and Attorney General,  filed a brief in support of a lawsuit filed by the Mississippi Insurance Department against FEMA for increasing the cost of flood insurance.  FEMA administers the National Flood Insurance Program (NFIP), the federal government residual market for flood risk. 

In their brief, the group argues that the increased cost of NFIP coverage is 
so high that many homes have become unaffordable leaving homeowners to choose between foreclosure and sale to escape the crushing financial burden imposed by the NFIP rate increases. In many instances, however, sale is not a viable option because the new exorbitant premiums render the properties unaffordable to potential buyers. This cycle has already begun to have a deleterious effect on the real estate markets and economy of the State of Florida. 
We are supporting Mississippi in their lawsuit against FEMA because the NFIP rate hike will not only hurt Florida families but will devastate our real estate market.
This all sounds remarkably similar to the accusations alleged at Florida's state run insurer, Citizens.  Consider, Sen. Mike Fasano
Homeowners can no longer afford these types of increases or even the premiums they're paying now...This is economic disaster for our state if they allow Citizens to continue to go in the direction they're going 
What can be drawn from this observation?  I make two conclusions.  The first addresses the function of residual markets in general.  The second addresses the political difference between Citizens and the NFIP.

First, residual markets, as public policies, have a ratemaking process that incorporates the views and concerns of the public.  Residual markets serve a supportive role in the state and national economy.  They provide "insurance" at a politically acceptable cost to support desired behavior such as, buying cars, buying houses, or going to the doctor.  As residual market rates change they create different sets of winners and losers.  This is where conflict over rates arise.      

Second, differences between the NFIP and Citizens has Florida Governor Scott looking to keep rates low on the former and raise rates on the latter.  Why?   Here are a few considerations:
  • The ability to spread risk by the NFIP over a population (ie. the nation) is greater than Florida's Citizens which can only spread risk as far as the state population.  Scott's constituency is the Florida public, many of which would rather not have the burden of other people's cat losses.  Higher rates for Citizens decreases the future burden on Floridians though doesn't really do much for those hurting today.  Yet, Scott has little if any accountability to those in other states.  
  • To my knowledge, no private companies or few private companies, offer residential flood insurance coverage in the United States.  So, to the extent that a homeowner cannot afford to purchase NFIP coverage or chooses not to buy NFIP coverage they have no other options. Windstorm in Florida is different.  There are many private market companies that offer wind coverage in the state of Florida.  So, lower rates by Citizens "competes" with the private market.  By demanding lower rates on the NFIP there are few constituent insurance interests that Scott risks upsetting.  But, by demanding lower rates on Citizens, Scott will upset all private market insurers in the state of Florida.   
  • This final point is more of a question regarding the science of estimating hurricane risk and the science of estimating flood risk.  Nearly every Tom, Dick, and Harry has an estimate for hurricane risk.  The measurement is highly malleable and changes routinely.  One estimate is scientifically, as good as the next.  But, I'm not sure to what extent this is the case for flood. How does the role of science differ in the ratemaking process of the NFIP in comparison to Citizens?    

Friday, November 1, 2013

Say it ain't probabilisticly so

The above image is from a featured article in The Economist. The article pointed to a substantial rate of publication in the scientific literature of false positives (thinking something is true when it is not) and creative or misleading correlations.   
Academic scientists readily acknowledge that they often get things wrong.  But they also hold fast to the idea that these errors get corrected over time as other scientists try to take the work further.  Evidence that many more dodgy results are published than are subsequently corrected or withdrawn calls that much-vaunted capacity for self-correction into question.  There are errors in a lot more of the scientific papers being published, written about and acted on than anyone would normally suppose, or like to think.  
The Economist attributes the rapid publication of potentially wrong results to political interests of scholars needing to advance their career.  
Professional pressure, competition and ambition push scientists to publish more quickly than would be wise. A career structure which lays great stress on publishing copious papers exacerbates all these problems.   
There is of course something regretful to be said for the quality of research that is at times published.  Still, that the information is published at all is not inherently a problem. 

The pressure to publish, though stressful, often has scientists working within a given area of thought and controversy rather than wandering about the knowledge world.  Areas of controversy often indicate that the resulting scientific consensus is meaningful for decision making out in the 'real world.'    

xkcd comics (xkcd.com)
Thus, every article must be placed into the context of an ongoing discussion.  When they are, surprising or questionable results are easier to spot.  

The problem arises when individual research papers are taken out of debate and social context and readily applied in society for decision making with large scale effects.  And as The Economist briefly mentions, this occurs regularly.

Consider for instance, that publication in a peer reviewed journal is the minimum requirement for use of a scientific finding in the creation of catastrophe models for ratemaking in Florida.  Even if the study is fiercely debated, it remains fair game for use.  The decision to pick a paper out of context and use it for ratemaking has far reaching consequences  socially, politically  and economically.  

As a resolve to this issue, The Economists seeks to revamp the peer review process applied to published work and demands greater replication in scientific studies.  

The idea that the peer review process leaves something for wanting is not new.   In this way, The Economists can get into a long line of interests that wish the published science said something other than what it does.  Certainly room for improvement is always possible.  But this topic is itself vast with a substantial context, so I won't go into it much further.

The need for replication may be an important alternative in studies that involve clinical trials and biomedical science (which the article heavily focuses on).  Outside of those fields though, scientific studies very often use predictive modeling.  Given the same model, replication of results is obviously possible, probable, and certain.  Amongst models with similar assumptions replication is also possible.  Unfortunately, in this type of research replication does not equate to truth about the future.  Therefore, replication is not always a suitable response to the problem of questionable research results.  It's most likely a discipline specific solution.   

Again, where decision making requires reflection on the state of scientific knowledge looking to where scientists agree and disagrees is more promising than relying on any one paper, peer review process, or ability to replicate.    

Thursday, October 3, 2013

The Competition between Government and Insurers

In light of our Federal government's shutdown over disagreement over the budget and the Affordable Health Care Act (ObamaCare). I share some excerpts from my dissertation and additional thoughts.
In many ways, the insurance industry rivals government.  Insurance has a governing effect on society by enforcing punishment in the form of monetary costs for behavior it judges as morally reprehensible.  When insurers’ sense of “moral risk”  conflicts with government’s the two compete for the public’s trust to identify those risks worth fearing or accepting.  Similar to government, insurance provides for the general welfare, creates employment, and contributes to national GDP.  To the extent that income going to taxes is unavailable for insurance premiums, the insurance industry and government compete for revenue to provide these serves.  In 2012, insurance policyholders in the United States spend over $1.8 trillion in insurance premiums.  By comparison, in 2011, the Federal government collected $2.3 trillion in taxes.  If considering revenue as a proxy for power, the insurance industry provides the Federal government a worthy opponent.   
Though the insurance industry and the government may seem as adversaries, the two have grown and prospered from a symbiotic relationship.  Beginning in the 1930’s, property and casualty (P/C) insurance has played a pivotal role in the success of Federal economic policies for real estate by providing windstorm coverage, which included the hurricane peril, to meet mortgage lending requirements.  However, around the 1960’s, insurers began struggling to manage the large catastrophic losses coming from the nation’s growing urban areas while also providing coverage at an affordable rate.  As a result, governments created P/C residual market to support the economic policies that depended on the availability of affordable property insurance.  
This is also about the same time that the federal government created Medicare and Medicaid.  According to the government's Centers for Medicare and Medicaid Services
The Medicare and Medicaid programs were signed into law on July 30, 1965. President LBJ is pictured at the signing ceremony in Independence, Missouri at the Truman Library. Former President Truman is seated beside him. LBJ held the ceremony there to honor President Truman's leadership on health insurance, which he first proposed in 1945. 
Truman's goal of federal health insurance came into conflict with the American Medical Association and his policy was eventually dropped.  But, the date of 1945 is significant for two reasons.  First, WWII ended in 1945 and troops came back, started families, and were able to take advantage of New Deal policies.   Second, Congress refrained from regulating much of the insurance industry by passing the McCarran-Ferguson Act (US PL 15) leaving it up to the states to do so.  Taken together, the increase in population, New Deal Policies, and the Act facilitated growth of the real estate sector and (I believe, for example here), the health and medical sector.  Now these two national wealth producing sectors rely on the availability of affordable insurance.  

However, for many reasons, which I will not go into here and now, the insurers have trouble offering coverage at a price that we are able to pay or willing to pay.  And so, we have seen the growth and expansion of P/C and health residual markets since around the 1960's. 
Residual markets are public policies.  Studying residual markets provides an opportunity to assess the implementation of the democratic process and roles of state and federal government in serving public objectives in managing risk.  Like any other public policy, the progress of residual markets in meeting stated public objectives is of interest to ensure a successful democratic governing regime.  The political controversy surrounding residual markets in recent years gives reason for their evaluation in relation to the goals policymakers have intended them to achieve.  Using a specific public policy [I use Citizens Property Insurance Corporation] as a case study of the democratic process reveals power relationships in society and points of contention thereby leading to a fruitful discussion for how policymakers can improve policy outcomes.    
The power dynamic between government and insurance is clearly evident yet often unexamined. Instead, each accuses the other unfairly pricing our society's risk (for example, here or here).  At they same time, the two refuses to address underlying policies and practices that lead to difficulties with implementing a successful and stable insurance regime.  It is this inability or unwillingness to address underlying issues that represent a failure of the democratic process.  

As the saying goes, "you can fool some people some times, but you can't fool all the people all the time."  A recent Gallup Poll, indicates that the public is aware of the government's democratic process failures and has chosen to favor politics over policy,
Americans are more likely to say the budget debate is an attempt by both sides to gain political advantage (47%) than an important battle over principles (37%).
Another poll, indicates that the public resents a government shutdown as an exercise of power over the decision making process of social well being policies, such as health care. 
Though politics without policy is largely inseparable  one without the other suggests a floundering governing process.

The Prediction Racket

I have not been posting regularly because I have been trying to finish up my dissertation.  Here is my dissertation abstract and the time/location of the defense.

Tuesday, October 8, 2013 at 2:45pm at the Center for Science and Technology Policy Research, University of Colorado at Boulder
The Prediction Racket: 
Constructing, Characterizing and Governing Florida's Hurricane Risk
The prediction racket describes a situation in Florida where insurance rate decision makers look to catastrophe models to reduce uncertainty about future loss and in the process characterize ever more risk.  To alleviate the racket’s affect on the public, the Florida legislature mandated its residual market, Citizens Property Insurance Corporation (Citizens), provide “affordable property insurance.”  However, Citizens struggles to satisfy its mandate because disagreement about the risk detracts from constructive debate needed to reconcile conflict between insurer economic sustainability and insurance affordability.  This undermines legislative efforts and threatens Florida’s democratic process.

This dissertation examines the interrelated social and decision process of constructing understanding of the hurricane risk, negotiating its characterization, and implementing insurance.  Three independent research projects address each part of the process.  First, I consider the conflicting claims that hurricane losses have increased due to geophysical changes or social changes.  I assemble a global dataset of hurricane landfalls and find no long-period trends, support earlier research conclusions that societal changes explain increasing losses.  Second, I present the ratemaking process as wholly political and examine the role of catastrophe models in the evolution of Florida’s hurricane risk affordability and insurability.  I find that, over the period of analysis, conflict over modeling science attributed to the decline of perceived insurability of Florida’s hurricane risk.  I conclude that without a means to judge the scientific quality of the models, they serve in the ratemaking process simply as political tools to support interests’ preferred rate decisions.  Finally, a policy evaluation of Citizens identifies trends in its success and failure meeting the goal of affordable property insurance.  I attribute responsibility for performance to four main factors: 1) the use of Citizens as means to deflect market judgments of risk, 2) the logical impossibility of an actuarial sound residual market, 3) the politicization of the hurricane risk, and 4) false assumptions in the state’s economic model.  The dissertation concludes with a list of policy options designed to expand the scope of debate beyond one of insurance ratemaking and towards considerations of policy that improve the availability of affordable property insurance.

Thursday, September 26, 2013

Florida's Contribution to World Cat Losses

Munich Re reported that between 1980 and 2012, 65% of the world’s natural catastrophe insured losses occurred in the United States.
This image can be found here

The Insurance Information Institute reported in there 2012 fact book that between 1980 and 2010, Florida accounted for 16.5% of all US insured catastrophe losses (III 2012).

Thus, I estimate that between 1980 to about 2010, Florida, alone, contributed to over 10% of the world’s insured catastrophe losses.  [(0.65 US Losses)*(0.165 FL Losses) = 0.107]

Tuesday, August 6, 2013

Managing the Multifaceted "Miami"

The Financial Times quoted me in a follow up to the Rolling Stones article about Miami and climate change.  The FT article' author, Simon Kuper's observed through his years of traveling back and forth to Miami that it "isn’t exactly a city; it’s the world’s biggest holiday resort."  This is an astute observation as Miami has long capitalized on the luxury vacation sector.  Perhaps the resorts have influenced the culture of the area so that all of Miami is looking for a good time all the time.  However, that is not to say the "Miami" is one big resort.  It is home to a great many people.  "Miami," I believe, needs some clarification.  

When people say Miami, they often think of South Beach and the Will Smith song, Miami.  Perhaps we owe this misnomer to the local politicians of the 1990's who sought to capitalize on Miami's fanfare by changing the county name to Miami-Dade County.  Luxury condos on the beach often reside in a unique municipalities like Miami Beach or Sunny Isles.  These areas are not the City of Miami, nor the the area that is known as unincorporated Dade. But the distinction is not often made and this hides realities about managing the area.    

"Miami" as a generalized name for a county, suffers from severe income inequality with wealth and poverty concentrated and localized with everyone else sprawling in between and west.  Despite the large population of transients, "Miami" has a great many people that permanently live there with little intention of going elsewhere.  I myself can claim to be a third generation "Miami" kid (though I'm currently not living there).  I have an extensive network of family and friends that live there, are from there and also have ancestral roots there.

I make this brief point because I believe that it is important to recognize that there are many, many people that do claim "Miami" as their home. When we think about planning for the future it is the local residents that need to be considered, their needs, and their well being.  The pursuit of Miami as a vision of luxury tourism enables oversight of those that call the area home.   Fostering the idea that Miami is but a vast tourist trap will masks burdens being placed on local residents as public policies are made.            

Portofino Tower South Point, Miami Beach

For example, I clearly remember Portofino Towers being built in the 1990’s.  It was highly controversial and a symbol of unscrupulous South Florida politics.  The endeavor came after a lengthy battle over a redevelopment plan for the area.  In 1973, a building moratorium was put in place for the southern most area of Miami Beach due to “blight.”  The area was home to an elderly low-income population and the city government goal was to bring tourism back there.  The moratorium and designation of urban decay was a self-fulfilling prophesy and partly responsible for continuous degradation.  Alex Daoud the young politician, lifted the moratorium in the early 1980’s and in its place came a redevelopment plan (see more in Daoud's Sins of South Beach).  The plan had little if anything in it to protect affordable living for residents in the area. As then aspiring politician Janet Reno who would one day be Attorney General to the Clinton Administration , put it,
The purpose of this (redevelopment) plan is not to clean up a blighted area.  The plan makes clear that primary purpose is the construction of a ‘tourist-oriented area.       
In any case, Thomas Kramer a German real estate developer bought up a bunch of land at the South Point area of Miami Beach with plans of developing the area much as it is today.  Local residents of Miami Beach were firmly opposed.  A political battle ensued over building regulations- especially density and building height.  Long story short, local residents won some battles but lost the war.  Today, real estate in the area is dominated by cash transactions with international investors.

Public policy that does not account for the realities of resident can have unforseen consequences when trying to manage the community on a larger scale.  For example, the measurement of risk and cost of insurance for a structure is tightly bound to aspects of its intrinsic value through the use of replacement value.  Though price and value are often posed as the equivalent, they are not the same thing.  Further, “value” is a multifaceted concept and not all perceive the value of something equally.  In an editorial in the Financial Times, John Kay, explains,
The fundamental value of an asset is derived from the cash or earnings or utility the asset generates. Prices can deviate from fundamental value because future cash or earnings or utility are uncertain, or because of momentum – the belief that overvalued or undervalued assets may become yet more overvalued or undervalued.   But there are few cases where prices are forever divorced from fundamental values – that was the lesson of tulips, dotcom stocks and collateralised debt obligations. 
The value of gold is that it is both beautiful and scarce. These characteristics made the display of gold a symbol of wealth, enhancing the value of the metal further. Diamonds acquired similar cachet in the 20th century as a result of inspired marketing. Yet the value of diamonds still lies in the utility they offer the wearer, even if that utility derives from the envy of others. 
I sometimes wonder about art masterpieces – how can owners obtain $100m of benefit from a painting so valuable that the original must languish in a vault? Still, many people can own a copy of a Picasso that only a few experts could distinguish from the original, but only one person can own that original. The utility derives from the owning – and perhaps from being known to be the owner – of the painting, rather than the joy of looking at it. The price of diamonds and old masters does not deviate from their fundamental value in use, even though the use and the fundamental value may be influenced by the price.

So, in the case of some properties, the value enjoyed by the owner is not necessarily equivalent to those that live their and have to look at it for their lifetime.  This is a problem for the implementation of a successful insurance regime because insurance is, by design, a socializing mechanism.  Insureds share in the collective risk because there is a shared interest in well-being.  Contempt towards a subset of the risk pool causes instability in the good-will necessary for smooth running of insurance.

One of the special things about "Miami" is that it carries a fun loving atmosphere and there are few if any place like it.  But it should not be mistaken for it being one large resort.  Certainly, for some Miami is a great vacation spot. But for many, many more it is home.   

Friday, July 19, 2013

Weinkle et al in Congress!

In a Congressional hearing yesterday, a graph from a paper I worked on was blown up for discussion.  The picture above shows the image with some senators.  A video of the hearing can be found here and the paper can be found here.

The hearing began with Sen. Barbara Boxer (D- CA) explaining that the hearing was about "climate change and the serious threat it poses to our nation.  This isn't a political hearing or a solutions hearing; it's a hearing where I hope we will listen to the experts."  She cited some scientists saying some things about what can be expected from climate change, some stats on disasters and disaster losses, concluding that climate change is real, happening, and posing a threat.

This was followed by Sen.  David Vitter (R- LA; in the picture on the right) who stated, that the hearing fell on the heals of Obama's announcement of a "sweeping climate action plan which will undoubtedly tighten the Federal government's grip on our economy" and that he looks forwards to "digging down into the science, what exactly it suggests and it doesn't suggest, and I certainly look forward to economic impact on the American people as they face very, very tough times."

The title of the hearing was "Climate Change: It's happening now."  Both Boxer and Vitter agreed with the title.  Yes, it is happening.  So the hearing had to be about politics and solutions because once people agree to a fact, they then have to decide what to do about it if anything.  So the scientific experts were being used to provide information that would explicitly or implicitly support or negate spending the model to implement the policies of Obama's climate action plan. This forced judgment of the goodness or badness of the policies on the scientific ability to attribute observed extremes to climate change. This is unnecessary and difficult to do.

The graph above indicates that there is no global long term trend in hurricane landfall frequency or intensity according to the reliable record.  The observation says nothing about the warrant in creating policy intended to adapt society to extremes like hurricanes or changes in extremes like those expected with climate change.  Regardless of climate change, policy that protects society from loss, disruption, and suffering seems like a good idea.  But the decision to implement those policies rests on felt "moral obligation" (as the Obama Administration called it) of which science has no authority.  

Wednesday, July 17, 2013


Recently, the politicians and the news have been awash with claims of a subsidy for flood risk provided by the National Flood Insurance Program (NFIP).  Similar sorts of claims have been and continue to be made about a subsidy for Florida hurricane risk.

But, how would you know a subsidy exists? What standard of comparison would you use? Is the existence of a subsidy dependent on perspective?

A classic measure of risk is average loss.  Traditionally in insurance this was called the pure premium- the sum of all losses over the number of years represented in the loss data. With the welcoming of catastrophe models, the pure premium became better known as the average annual loss (AAL).  The AAL is similar but different to the pure premium.  The AAL is calculated by multiplying the probability of a certain size loss times the loss, then adding all those up.  This is done for an entire model's event catalog.

Above is a graph comparing the estimated annual Florida hurricane loss by model type.  The first three estimates are pure premiums found using a commercial company catastrophe model for the all lines industry portfolio for Florida.  From left to right, the first two differ only by the inclusion of storm surge and run on a "stochastic" or "near term" catalog. The third is the company's FCHLPM approved model which means it has a "historic" catalog.  The final estimated is the AAL for normalized Florida historic event economic losses.  These were gathered from here.  Economic losses divided by two is a standard way to estimate insured losses.  One thing to note, all but the historic AAL includes estimates for demand surge.

In both 2011 and 2012 Citizens, alone, brought in about $2.2 billion in earned premium (written was similar).
There are, of course, many reasons not to rate and price insurance solely on the AAL or pure premium.  But, choosing one estimate of risk over another, particularly an estimate other than a historical average, represent hedges. There are tradeoffs in doing this. The table below shows each model's annual loss estimate compared to the normalized historic loss events. (There are some caveats for event loss versus loss year but this is fine for demonstration purposes).  Consider the annual loss estimate to be a prediction which will rarely if ever be spot on, but will come in too high or too low compared to the observed event.  The table demonstrates tradeoffs and compromise in the political process of ratemaking.

For example, using the pure premium from the Historic model, policyholders would be paying too much 68% of the time but too little 32% of time.  When policyholders are not paying enough to cover losses, insurers are burdened with the risk of running a deficit.  In comparison, using the Wind model, policyholders pay too little 13% of the time but too much 87% of the time.  This scenario sees insurers’ decreasing the probability of not having enough money for a loss and increasing profitable years, but it also increases the frequency that policyholders pay more than they needed.  Interestingly, the Wind +Surge model estimates a larger pure premium than wind alone, but with no change in the number of times the estimate comes up too high or too low.  It would seem that there is no added advantage, however, consider that the insurer is making a little bit more every time the estimate proves too big.  Given that policyholders do not want to pay more than they have to for their coverage, an 11-71 split will appear undesirable to purchasers of insurance.  Thus, the Approved FCHLPM model represents a compromise.

Thursday, July 11, 2013

Sea Level Rise and Miami Beach: Context to the policy issues discussed in that Rolling Stones article

NOA: www.tidesandcurrents.noaa.gov/sltrends/
Recently, my inbox has been awash with stuff about climate change induced sea level rise (SLR) and Miami Beach.  The NOAA reports that the average sea level rise in the Miami area has been 2.39 + 0.43 mm/yr (yes that is mm) or 0.78 + 0.14 ft/century (yes that is 100 years).  

The question of course: Does 2.4 mm/yr warrant action and if so, what action?
A recent Rolling Stones article outlines three policy issues in relation to talk about SLR and Miami Beach, the context for which the article's author, Jeff Goodell, neglects.  In italics, I present the Rolling Stones problem frame and policy solution.  Then some context.

SLR will cause salt water intrusion and limit the availability of freshwater therefore, a desalination plant is needed.
For many decades Miami has been interested in a desalination plant, but the cost has proved politically prohibitive. The concern was/is that South Florida population was lowering the water table which would be devastating to the Everglades ecosystem, cause salt water intrusion, and problems with the availability of fresh drinking water (and sinkholes as demonstrated in northern Florida).  What is more, (my impression has been) if the population was less reliant on the Everglades for fresh water then more of it could be available for development.

SLR will flood Miami Beach therefore, a development plan and infrastructure update for the area is needed that force people to move out of the area.
In the 1970's, a South Beach/Miami Beach Redevelopment plan was advocated for which included a number of dikes and canals for the Miami Beach area.  The goal of that plan was to create an exclusive community and get rid of lower income residents which were considered a contributor to "blight."  The Venice like aspect of the plan never came to fruition, but apparently never went away either.  Ridding the area of lower income residents however was achieved quite successfully.

In addition, there has been much recent advocacy for increasing investment into existing US infrastructure (roads, water treatment).  Recently, The Economist featured Miami in its own assessment of this infrastructure debate.  Arguing that infrastructure should be updated in Miami Beach due to SLR is simply to take advantage of an existing demand for investment of this kind.    

SLR will cause hurricane losses to become more severe, therefore the cost of insurance needs to increase to communicate this risk. 
Florida has been having problems with their windstorm (hurricane) insurance since the 1970s due to trends in development.  Climate change is no more a factor for this than is the moon made of green cheese. However, if climate change is accepted as something that is affecting losses through impacts on hurricanes, etc., then the science used to establish insurance rates can be altered.  There is a great international financial interest in this for several reasons which have little to do with climate change.

Climate change science, including investigation into changes in mean sea level, has been very informative over the years and "climate change" is an important, complex global issue.  But the primary problem here for Florida, Miami, and Miami Beach is a moral and ethical one regarding desired land management policy (including population growth and density) for Florida's future.  Believing that the former dictates courses of action for the latter is not only false but impossible and effectively removes the public from participating in constructive public debate about the future of where they live.

Tuesday, July 2, 2013

Does Florida have a competitive P/C insurance market?

Healthy competition is much in the eye of the beholder. There are often rules- fair fight tactics.  Generally, there are winners and losers.  For certain though, competition requires more than one player. Depending on the context, different numbers of players are desirable.  For example, most card games can be played between two people but much more interesting and fun when played with four.  

In a market, let's say a Florida P&C market, how many participants is sufficiently competitive?  

Tales from Hurricane Andrew and fierce competition that pushed rates "too low" seem to suggest that too much competition is an equivalent bad to too little.  

Below are graphs comparing the number of domestic P&C companies by state.  The top graph shows number of companies per person adjusted to the average ratio.  The below graph shows number of companies per state adjusted to the average numer of companies. Population and company data reflect the year 2010.  P&C data gathered from the III's Insurance Factbook, 2012.

*Delaware value= 8.49

In the context of state population, Florida is below average, but not the lowest and comparative to many other states.  Yet, when considering number of companies by state, Florida is well above average.

Is it competitive?   It would appear to me that yes, Florida has a competitive insurance market.

Is it as competitive as one may hope? I suppose that is open to interpretation.

Thursday, June 6, 2013

Occupy Citizens

One of the great laments by many people in Florida is that Citizens Property Insurance Corporation acts as a grand subsidy for rich people with million dollar homes on the coast.  As such, in the past couple of years and most recently with SB1770, the "rich" (apparently defined by the replacement value of your home) are being kicked out of the state run Citizens.

And while great anger and frustration are focused on these wealthy homeowners, the graph above from Citizens' 2010 Annual Report shows that the majority of policies in the company are worth far less than a million dollars.  In fact, the category with the most policies is the $200-400k range, which in many parts of Florida, cannot be considered lavish.

So who are these million dollar babies?  In early 2012, Lynn McChristian who writes a blog covering Florida insurance for the Insurance Information Institute, reported that 7,500 Citizens policies had a coverage range of $1-2 million.  According to the numbers in the graph, then, this is the 1%.

At the time, Citizens reduced eligability to those with no more than a million dollars of coverage.  As McChristian points out, that some would question the wisdom of taking these policies out of Citizen.  Though they have the most in exposure per policy, they are also paying the most in premium.  Kicking them out is a loss in premium with an insignificant reduction in exposure.

Further, if these policies are picked up by undercapitalized take out companies, then the public is still on the hook for the exposure without the benefit of the premium.  

Perhaps, little had been solved.  

Right now, the new legislation set forth by SB1770 will continue kicking the upper crust out of Citizens until it reaches those with coverages for $700,000.  According to the graph above, it's hard to imagine that this will really be all that many policies.

Instead, this is a political win more than anything that has to do with running a sound insurance regime- the success of which goes well beyond the confines of Florida's Citizens.  The legislation is a product of a renegotiation of the rules guiding who ought to have access to a public defined hurricane risk.  Removing the top echelon of the Citizens' "public" enables politicians to appear tough on the rich that take avantage of public resources.  (Whether or not these people are in fact "rich" or just the victims/beneficiaries of increasing replacement costs).   At the same time, the private market is happy because they get to have access to a larger part of the market, especially those that, in theory, can afford top dollar risk.    

It will be interesting to see how long this goes on and I suspect it will have little to do with controlling or reducing Florida's hurricane risk and much to do with the state's economy.  While $1 million has a nice ring to it, the real value dwindles over time.  Dr. Evil learned this the hard way back in 1997.  This is especially true in a volatile housing market like Florida's with homeowners making far less than the value of their home (market, replacement, or otherwise).  It is hard to imagine much of a rally around ousting the 40% scumbags living in $300,000 homes.

Thursday, May 23, 2013

Mud in the Crop Insurance Tires

Thanks to tinyprayers at flickr.
Last month, the Environmental Working Group, an advocacy group focused on minimizing government subsidies, released a report on crop insurance.  Bruce Babcock, an economist from Iowa State University, authored the report.  The report was big news, picked up in several places including NPR.

The EWG report focused attention on a type of policy that offers revenue protection, which it dubs the Cadillac Crop Insurance Policy.  The central argument is that payouts are greater then premiums demonstrating a public subsidy.  The report advocates that "farmers pay a larger share of the incremental cost" of the insurance coverage to reduce the subsidies.
EWG Report p.15
However, uncertainty about revenue is a speculative business risk.  These types of risk are uninsurable because they encourage willy-nilly risk taking in the marketplace to the potential sacrifice of public policy goals of wellbeing.

So, the coverage in question being offered by the Feds is not really insurance.  It may be called as much for whatever reason, but it's more akin to a financial mechanism like, perhaps, a put-option.  The EWG report alludes to this at the end of the report when it argues that the Cadillac coverage is a means to hedge bets in agricultural trades.
There is only one possible risk management benefit for farmers who buy RP. Farmers who forward sell their crop face the risk that they will not have enough yield to deliver on the contract. If the price of the contracted commodity rises, producers with a short crop will lose money because they must purchase more expensive grain to honor their contract. Farmers who forward contract the exact same proportion of their crop that they insure with RP will find that the additional payout under RP compensates them exactly for this hedging loss. Thus purchasing RP lowers the risk to farmers of forward selling their crop. 
Perhaps, it is the case that the program was intended as insurance but over the years, develoved into a political tool of some sort used to stabilize aspects of the economy.  This would be similar to Florida's Citizens.  I am not familiar enough with the history of US agricultural policy to say.  

My only point here is that attempting to solve a perceived problem with insurance, that is not in fact insurance, muddies the policy waters, masks the underlying debate (whatever that may be) and misleads expectations of policy outcomes.  It also facilitates movement into an endless battle over the right risk so as to charge the appropriate premium.  This skirts the debate about whether or not the public wants the agricultural market risk at all, why the financial mechanism is in place, who wins and who loses from removing or altering the program, and other possible solutions.

Friday, May 17, 2013

(one) Infinite Agent of Change

The use of catastrophe modeling permits participants in the ratemaking process to battle different perspectives of risk through scientific information, each with a with a guise of accuracy.  Competing perspectives view each other as foolish or manipulative while carrying the assumption that a true or real measure of risk is not only possible, but they have succeeded in its identification.

The reality is that different assumptions lead to different measures of risk; and with today's increasing complexity in modeling, risk estimates have no bounds.  A measure of true, correct, or right risk is not possible.

It seems that economic markets (where risk is a good that carries a handsome price) favor the limitless production of risk estimates.  However, public pocketbooks have constraints far narrower than the global risk transfer system.

In my previous post, I argued that Citizens is a mechanism to control the bounds of Florida's hurricane risk.  Where it creates these bounds implies different information and assumptions about future loss behavior.  In doing so, Citizens limits the amount of market contrived risk imposed upon the public as hurricane risk.  Without arguing that Citizens is the best policy tool for accomplishing this task, the alternative is a boundless, infinite conception of risk based on economic market goals.

A recent report from RMS,  describes an upcoming model platform that provides everyone the ability to be their own unique agent of change and demonstrates the "To infinity and Beyond" practice of estimating risk.  The report tells of standard practices in the industry of pricing, selling and trading risk and emphatically highlights that no two entities have the same quantification of risk.  The upcoming modeling platform, known as RMS(one) to be released in 2014, promises to permit for an even more diverse array of assumptions and views of risk.  Here is the executive summary.
Many RMS clients take steps outside of modeling applications to develop their own view of risk— running sensitivity tests, adjusting model loss, and blending model output. Until RMS(one), catastrophe models have not offered insurers and reinsurers the ability to develop their own view of risk, tailored to their guidelines and representative of all exposures. 
The ability to flexibly investigate modeling assumptions, improve the understanding of uncertainty and portfolio sensitivities, and combine losses from numerous sources leads to better business decisions, more efficient use of capital, and ultimately a more resilient risk management strategy. It is no longer enough to have a “one size fits all” approach to risk modeling—our clients need to be confident that their view of risk reflects the uniqueness of their portfolios. Finally, insurance regulators and supervisors increasingly require companies to demonstrate that they fully 
understand the modeling basis for their submissions.  
The RMS(one)™ environment supports (re)insurers in developing their own view of risk, by delivering “open modeling” through the RMS MetaModeler. Clients can incorporate their own research and experience into their modeling; manage model change; prepare market submissions; and meet their regulatory obligations in an efficient, transparent, and documented way.  
Open modeling increases model understanding, enabling our clients to customize RMS models by adjusting or overriding model components and data. Clients can host their own models in the RMS(one) environment—as well as non-RMS models and model results—and can blend model output.  
Through this suite of open modeling capabilities, RMS(one) enables clients to make defensible, transparent, auditable changes to their models and model output in one efficient experience. By gaining control over model assumptions, clients can develop a tailored, complete view of risk at all organizational levels. For the first time, they can confidently validate model applicability on a single platform and can test and modify model assumptions, data, and components, bringing resiliency to their risk management strategy.

Thursday, May 9, 2013

What does Citizens do?

Recently, I have noticed insurance literature referring to Citizens as the "so-called" residual market mechanism   This conjures memories of a Manic-Panic punk-red, Claire Daines lamenting her So- Called Life.  It is the same situation.

The angst ridden, fictional teenager, Angela Chase, felt she had little control over her daily coming and goings.  What was supposedly her life, to live guided by her own expectations, was heavily influenced by the decisions, wants, and needs of those around her.

Insurers believe they should have control of Florida's residual market mechanism (RMM) as a tool to stabilize the property insurance market.  Their decisions ought to dictate what risks are put into the RMM and at what cost.  A so-called situation arises when insurers feel that the RMM has fallen out of their control, overtaken by the decisions, wants, and needs of others.  Hence, the tragic angst regarding Citizens, the so-called RMM.

Despite teenager and insurer disgruntlement, many saw Angela Chase as a bright promising young adult, similar to those that appreciate Citizens as a saving grace.  In order to understand the dissatisfaction with Citizens, we must first understand what it is intended to do...

Fundamentally, Citizens controls probabilistic "tail risk" by providing coverage for the stuff that insurers don't want because they think it is too risky.  In other words, it "caps" the private market risk.  As a state run entity the tail risk becomes the public's responsibility.  The controversy comes from deciding where the tail begins and how thick is the tail.

Below is a generic probability distribution of losses.  The graph shows a high probability of small loss with gradually lower probability of large loss.  When Citizens sets its rates, it inadvertently designates the tail because the price an insurer can charge is a limiting factor of the amount of risk they can take.  Where decision makers draw the line between private market risk and RMM tail risk is arbitrary, negotiable, and controversial because it defines winners and losers in society.

Claims made about whether or not Citizens is truly an "insurer of last resort" speaks to this negotiation about the tail.  If an insurer believes that the unwanted tail risk begins at the blue arrow, then Citizens rates at the purple arrow will appear unfairly competitive.  Citizens does this to help control policy cost in the (very) short run.  However, the decision may be at the sacrifice of public long run benefit because the public gets stuck with more large loss risk.

But we also have to decide the thickness of the tail or rather, how quickly the probability of large loss diminishes... that is, if it diminishes at all.  The below graph shows a "fat tail," where the probability of big losses is greater than that in the above graph as well as non-diminishing.  With the fat tail, there is a relatively substantial probability that really big loss, (limited only by your wildest imagination) will occur.
Fat Tail
Choice of tail thickness has implications for how wise or good a rate decision appears to an onlooker.  If one believes to have information that indicates a thick tail, then the decision to make rates based on a thinner tail would appear to be willful ignorance.  On the contrary, those that believe the tail to be narrower view those peddling a thicker tail to be exaggerating the uncertainty.  In both cases, either party waves their modeled information around and looks to the other as being foolish at best, and manipulative at worse.  

Dissatisfaction arises because all conflicting opinions involved believe to be doing the public a so-called favor.

Thursday, May 2, 2013

Dirty Cash: Exploring Potential Solutions to Florida's Hurricane Insurance Woes

The issue of insurance "rates" nauseatingly consumes Florida’s public debate about hurricane risk.  On one hand, the private market wants higher insurance rates to mirror their beliefs about higher hurricane risk.  On the other hand, the Florida public wants lower insurance rates to mirror their beliefs about lower hurricane risk (or lower as compared to other risks).  In order to provide for the public welfare with a stable insurance market the two hands must meet somewhere near the middle. This will not happen without addressing the underlying issues with housing affordability (both costs of ownership and incomes) and building practices.

This ought to be great news for policy makers because it broadens the realm of possible solutions beyond the heavily politicized discussion of hurricane rates and risk.  For example, if the problem were better understood as one of distorted real estate markets and undesired building then perhaps addressing Florida’s tax evasion and money laundering might be helpful in relieving the hurricane affordability-insurability problem.

In the 1970’s and 1980’s Miami became a hub for cocaine trafficking.  Historians argue that this sudden influx of cash into the city’s economy brought forth unto this world the Miami of today, characterized by its modern financial and real estate economy.  At the hight of the cocaine trade, 20% of all real estate transactions in South Florida were paid in cash and caused an inflation of real estate prices.

Current statistics suggest that this tradition of money laundering is alive and well in the state.  According to the Department of Justice,  the Florida of today ranks fourth for “suspicious” banking activity.  The FBI reports that Florida is a national leader in mortgage fraud.   According to the  February issue of The Economist the world’s wealthy use Miami as a hub for “off-shore” banking activity- including tax evasion and money laundering.  The magazine reported that America keeps its “dirtiest” money on “Brickell”- as in Brickell Ave.  Perhaps not so coincidently, South Florida real estate purchases are predominantly  in cash- especially on the luxury end.

Florida’s queationsable financial scruples may significantly be impacting its social and economic systems causing difficulty for the successful implementation of an insurance regime.

In drug exporting countries, policy analyst Ignacio Navarro at the California State University- Monterrey Bay has demonstrated (for example here) that the illegal drug trade significantly contributes to increases in construction and housing prices.  He concludes,
… the strong cocaine export effect on urban construction and housing prices is mostly caused by money laundering that artificially inflates the demand for housing in these urban centers…  Illegal goods impact urban economies not mainly through employment like legal exports do, but through money laundering. This difference has profound implications for long-term economic development as they tend to create boom and bust cycles of real estate prices that can be catastrophic for local economies (and here).
Organized crime and corruption expert Louise Shelley at George Mason University has documented several instances where money laundering into real estate has had negative consequences for society, including some OECD countries:
  • exacerbation of economic bubbles in Japan and Dubai,
  • price increases of South Africa homes, 
  • “over construction of expensive housing and hotels” in Turkey and South America,
  • urban decay in Ohio (the US state), and
  • environmental degradation in Italy.

There is nothing here to suggest that Florida’s hurricane affordability-insurability problems will surely be solved by addressing the legality of how money enters the state.  Nor do I mean to argue that all of the money entering Florida does so illegally.   

I am arguing that Florida's hurricane insurance situation will not be resolved be endless debate about rates because the competing parties have different values at stake.  However, compromise may be found by addressing underlying distortions in the social and economic system.  Florida's tradition of money laundering may be one place to start.

Tuesday, April 2, 2013

Who benefits from uncertain virtual hurricanes?

A common belief is that a model of normalized hurricane losses (for instance given here) contains greater uncertainty then does more complex models of loss.  Below, is a table showing the correlation of variation (CV), a common metric of uncertainty, for several different types of models.  Highlighted in yellow, is the CV for Florida’s recorded economic hurricane losses between 1900-2008, adjusted for changes in society (e.g. wealth, inflation, and population).  The second row shows the CVs for several commonly used models of historic (1900-2008) insured disaster losses estimated using assumptions about the interaction of the social and geophysical systems.  The third row, gives CV’s for insured loss estimates using stochastic hurricane catalogs that use assumptions about interactions in the geophysical system in addition to the interaction between the social and the geophysical events. Data for the second and third rows were gathered from model submissions to the FCHLPM under 2009 standards.

By this metric, it appears that the measurable uncertainty in the normalized model is not much different from other models and generally lower than the stochastic models that are primarily used in insurance ratemaking. Also, the range of CV for these several commonly used models indicates that decisions about models are based on something other than measurable uncertainty (otherwise, the model with the lowest CV would always be chosen).

Unmeasurable uncertainty is inherent in all models.  This type of uncertainty comes from a lack of complete knowledge about the world.  For instance, what is the certainty about the accuracy of loss data pre-1950?  There wasn’t much by way of insured hurricane loss data prior to the widespread sale of the homeowners insurance policy in 1950 and prior to about the mid 1980’s, hurricane damage losses were not consistently collected in any orderly way.  So, judgment of this uncertainty is based on personal feelings about preferred means of estimating loss.

Many shy from the mash up of historical loss data from a variety of sources- newspapers, meteorological reports, etc.- and assumptions about the rate of population and wealth growth on regional and local scales.   They prefer the consistent means of generating past loss estimated by using vulnerability functions.  But even still, losses generated in this way are expected to resemble experienced losses- that is, what is accepted to have been experienced and constitutes a resemblance.  Consequently, the knowledge limits that exist in the historical loss data exist in the modeled losses, in addition to the knowledge limits associated with predictive functions.

So the presumption that one model is more uncertain than another model is a reflection of preferred depictions of past and/or future reality.  But who ought to have the power in constructing virtual realties or choosing among them?  This matters because in the "real world" people stand to benefit or lose from the implementation of models in decision-making.  For example, Aon Benfield claimed that record levels of reinsurer capital is due to a lack of catastrophic losses which is "a reasonable departure from the building view of a "new normal" higher level of global catastrophes."

But unlike the risk, the money is not virtual.  It came from the pockets of policyholders.

Thursday, March 7, 2013

Accurate and Reliable or just Politically Acceptable?

Models approved by the FCHLPM are said to be accurate and reliable.  Which is not saying much.  Accuracy traditionally means that a prediction shows a close correspondence with observations.  The dictionary definition would be that a prediction is "correct."   But given the time frames and probabilistic nature of catastrophe model predictions it is not possible to show that the models are accurate (no less skillful).  Thus, the FCHLPM redefines accurate to mean “the models meet the standards that have been developed” because "‘accurate’ cannot necessarily mean that a model conforms exactly to known facts since that contradicts the nature of the modeling process" (p. 39).

That a model is reliable means that it “will consistently produce statistically similar results upon repeated use without inherent or known bias.”  My understanding of this is that every time the user clicks "run" the model comes up with a similar result.  But even if interpreted differently it no less means that a model that is consistently wrong is no less reliable.  Consider a model that consistently predicts no hurricane losses or one that consistently predicts an annual loss of $500 B. In each case, such a prediction is as reliable as it is counterintuitive.

Below are graphs of accurate and reliable model loss predictions (for hypothetical data sets) approved by the FCHLPM.  Predicted loss is adjusted to the long term modeled mean for AAL and 250PML, respectively.  There are some interesting things to note...    
First, that red line that seems to be doing its own thing is produced by Applied Research Associates (ARA).  This company holds a great many Federal contracts for different technological things and it boasts that it's HurLoss model
Since 1998 it has been accepted by the American Society of Civil Engineers (ASCE) for setting national hurricane wind speed standards.
As such, this model is referred to often when building codes are being considered. So for instance, when the Florida Building Codes were under review, the ARA model was used for the review process.  Note that this model's risk estimate peaked in 2002.  Anyone remember what happened in Florida in 2002?  A massive overhaul of the building codes making them more stringent for wind.  Interesting, I think.

What is more?  All the models appear to converge around an average value in 2007.  Anyone remember what happened that year?  Citizens "capped" the conception of hurricane risk with changing eligibility requirements for coverage.  Coincidence?  Perhaps.  But more likely, legislative action created some politically acceptable risk bound.  

Another interesting point of note, is that the Florida Public Model began making submissions to the Commission in 2007.  It's average annual loss (aka Pure Premium) prediction was the highest of all the models.  This is notable because the model is legislatively mandated to serve as the minimum benchmark for Citizens rates.  Further consider that the long term risk, 250 PML, for the public model is at the low end.  According to this model then, Citizens risk of deficit from a low frequency, high severity hurricane event is small as compared to the other models and that risk is balanced by a higher estimate of annual risk.  

So, are any of these models any more accurate or reliable then the next?  Do any of them show a true or real depiction of Florida's hurricane risk?  No they do not.

What they suggest is that modeling companies have different clientele with different needs.  Each model, shows a different idea about the Florida hurricane risk that can be used to support chosen political positions and policies.