Potential Economic Value of Seasonal Hurricane Forecasts

Abstract

This paper explores the potential utility of seasonal Atlantic hurricane forecasts to a hypothetical property insurance firm whose insured properties are broadly distributed along the U.S. Gulf and East Coasts. Using a recently developed hurricane synthesizer driven by large-scale meteorological variables derived from global reanalysis datasets, 1000 artificial 100-yr time series are generated containing both active and inactive hurricane seasons. The hurricanes thus produced damage to the property insurer’s portfolio of insured property, according to an aggregate wind-damage function. The potential value of seasonal hurricane forecasts is assessed by comparing the overall probability density of the company’s profits from a control experiment, in which the insurer purchases the same reinsurance coverage each year, to various test strategies in which the amount of risk retained by the primary insurer, and the corresponding premium paid to the reinsurer, varies according to whether the season is active or quiet, holding the risk of ruin constant.

Under the highly idealized conditions of this experiment, there is a clear advantage to the hypothetical property insurance firm of using seasonal hurricane forecasts to adjust the amount of reinsurance it purchases each year. Under a strategy that optimizes the company’s profits by holding the risk of ruin constant, the probability distribution of profit clearly separates from that of the control strategy after less than 10 yr when the seasonal forecasts are perfect. But when a more realistic seasonal forecast skill is assumed, the potential value of forecasts becomes significant only after more than a decade.