Small Storms May Do The Biggest Damage
No one in the insurance industry will ever forget Hurricane Andrew. Its 130 mile-per-hour winds ripped across South Florida in August, 1992, tearing a $16 billion hole in the industry's balance sheet. Ever since, insurance companies have agonized over when the next cataclysm would hit, seeking out expensive reinsurance and even exotic financial instruments to protect them against the effects of a $20 billion mega-catastrophe. "The industry got a pretty significant wake-up call from Andrew," says Ronald E. Foley Jr., who heads risk management at Travelers/Aetna Property Casualty Corp.
But some on Wall Street and in the industry wonder if insurers got the right message. Their focus on preparing for the Big One may make them more vulnerable to smaller, yet costly disasters. Historically, companies have purchased plenty of reinsurance, or coverage from other companies, to limit the risk of a major hit. But as reinsurance costs have soared, companies have been cutting back their reinsurance coverage for less onerous catastrophes. Where reinsurers picked up 50% of the losses from Hurricane Hugo, that fell to one-third by Andrew--and by 1994, only 20% of the losses from the Northridge (Calif.) earthquake were covered by reinsurers. "One way to reduce expenses is to stop [paying] premiums to reinsurers," says John Cashion, executive vice-president of marketing at reinsurance broker Willis Faber North America Inc.
MORE VOLATILE. Today, it would take an industrywide loss of about $3 billion to trigger most reinsurance coverage, vs. $500 million at the time of Hugo in 1989. Insurers "are protecting themselves against a $50 billion event, but it is the $1 billion event that is going to hurt them," says Merrill Lynch & Co. analyst Michael Frinquelli. The end result? Insurance company profits may be more volatile than people realize.
The new approach to catastrophe management is about to undergo a road test. Colorado State University hurricane expert William M. Gray predicts that the 1997 hurricane season, starting on June 1, will be whipped by seven hurricanes, three with sustained winds above 100 mph--the third consecutive year of above average hurricane activity. Indeed, weather specialists expect more tempestuous tropical weather to disrupt world patterns for at least the next two decades. Already, the storms that triggered the Biblical-style floods in the Midwest this year are expected to set insurers back $265 million--but that's just the cost of rain and wind damage, since floods are not covered by most insurance. Still, it may help push the number of claims past 1996's record 3.8 million, which cost $7.35 billion.
CALAMITIES. Inclement weather already has injured insurers. Since Hugo, catastrophic losses have jumped to more than $3.5 billion on average a year, from $775 million in 1989. Frinquelli says that losses from catastrophes in the 1990s cost 3 cents to 4 cents for every dollar of premium collected, twice what they cost in the 1980s. Take the fourth-quarter 1996 results for Chubb Corp.: Earnings per share were a nickel short of analysts' expectations because many small catastrophes fell under Chubb's reinsurance safety net. Salomon Brothers Inc. analyst Michael A. Smith expects the problem to continue to haunt 1997, and has trimmed his 1997 profit estimate by 4%. Says Chubb Senior Vice-President Gail E. Devlin: "We didn't have any big ones. It was a frequency issue."
Companies argue that mergers are making the property-casualty industry stronger and better capitalized. Also, sophisticated computer modeling helps track exposures better, to avoid excessive concentrations in regions predisposed to storms or earthquakes. And some insurers are exiting the business or cutting back sharply on the type and amount of business they underwrite. For instance, Allstate Corp., which suffered some $2.3 billion in claims from Andrew, has cut its maximum exposure to Florida homeowners to $1 billion.
Even so, the accumulating evidence suggests that the industry isn't as protected as it thinks it is--and that many insurers' balance sheets could sustain an extended period of devastating storm damage.
To continue reading this article you must be a Bloomberg Professional Service Subscriber.
If you believe that you may have received this message in error please let us know.
- ‘No Cash’ Signs Everywhere Has Sweden Worried It's Gone Too Far
- Boom Turns to Bust for Millennials Across Advanced Economies
- How One of the Most Profitable Trades of the Last Few Years Blew Up in a Single Day
- Dollar Steady, Oil Rises as European Stocks Falter: Markets Wrap
- Saudi Arabia Is Taking a Harder Line on Oil Prices