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Why Hurricane Sandy Was a Disaster – But Not For Insurers

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By any measure, Sandy was a devastating storm. The storm itself caused over a hundred deaths and perhaps as much as $50 billion in damage in the U.S.  The storm caused another $2.4 billion in additional damage outside of the U.S., in Jamaica, Haiti, Cuba and the Bahamas.

Ordinarily, a storm like that would translate into a huge hit to the insurance industry. But while insurers aren’t exactly ecstatic about having to pay Sandy-related claims, it could have been a lot worse for insurers.  Why is this the case?

Sandy’s Destructive Path

In terms of sheer size, Sandy was the largest North Atlantic hurricane on record.  While that doesn’t necessarily translate into wind speed (it hit the shore as a tropical storm, not a hurricane) it did translate into a truly enormous volume of water getting pushed ashore as storm surge.  This is where the vast majority of the damage in New York and New Jersey came from.

Insurers, Not Houses, Will Stay Afloat

Unfortunately, the reason it could have been worse for insurers is the least desirable reason possible; homeowners in the northeast are grossly underinsured.  The reason for this is that standard homeowners’ insurance policies don’t cover flood damage. You need a separate flood insurance policy to cover this particular threat.

While flood insurance is routinely required in Florida and other frequent hurricane destinations in the coastal southeast, only 14 percent of homeowners in the northeast held flood policies.

That’s up sharply from the 5 percent mark of just a few years ago. A lot of people in the affected areas went out and got flood insurance after Tropical Storm Irene, but a lot of people didn’t secure coverage – and those folks are sadly going to be paying dearly out of pocket.

Insurance Companies Need Insurance, Too: The Reinsurance Industry

Most people don’t realize it, but your insurance companies take out insurance coverage of their own. For example, an insurance company’s chief financial officer may feel confident in his portfolio’s capacity to pay out $10 billion in claims in a short period of time. But for amounts in excess of that figure, he may sign a contract with another, bigger insurance company, with a bigger reserve of capital. That company is called a reinsurer. Essentially, that $10 billion functions like a deductible at the insurance company level. The reinsurer typically backs up the insurance company for so-called mega-cats, or mega-catastrophes, beyond the capacity of the insurance company to handle.

Out of the potential $50 billion loss among U.S. property owners, the current estimated cost to the insurance industry is close to $20 billion – a big enough hit to exceed the deductible levels of the primary insurers and spill over into the reinsurance market.

Investment Outlook: Should You Invest in Insurers?

For those interested in possibly investing in insurers, there are basically two levels to look at.  First, there’s the effect of the storm on the primary carriers, some of whom did take a big hit to their bottom lines.  Second, there are the reinsurance markets.

According to the industry newsletter Insurance Insider, The four insurers with the biggest P&C exposures to the Northeast coast are State Farm, with 8.92 percent of the market, Travelers, with 8.41 percent of the market, Liberty Mutual, with 7.83 percent of the market share, and Allstate, with 6.83 percent of the market share across all lines, including auto, business and homeowners insurance.

We see less diversity in the homeowners market, though: 17 percent of the losses in the homeowners market will fall on State Farm, 14 percent on Allstate, and about 10 percent on Travelers. The top 10 carriers account for 72 percent of the homeowners market in the most severely affected states. That means two things: Bigger losses for the carriers that are in it, and a bigger spillover into the reinsurance markets.

However, 2012 has been a very modest year for storm damage so far – especially early in the year. As bad as Sandy was, the losses from Sandy are very much in the range that insurance companies expect to have to pay from time to time. They aren’t happy about it, naturally. But there won’t be any insurers going insolvent as a result of the storm.

Insurance Stocks Are Still Intact

Allstate (NYSE – ALL) barely budged. It fell right around the time the storm hit, because of shareholder uncertainty about the extent of the damage. But at $38, it has actually recovered slightly and remains above where it’s been trading for most of the year.

Travellers (NYSE – TRV) also hasn’t taken a hit. It declined a bit from its pre-Sandy peak, but is still trading well above where it’s been all year.

State Farm and Liberty Mutual are both owned by policyholders, rather than stockholders, so they aren’t publicly traded at all.  So Sandy, for all of its human tragedy, barely moved the needle, as far as the robust insurance U.S. market is concerned.

Global Reinsurance Markets Remain Calm

The second level of analysis is the reinsurance market. The reinsurance companies are the ones taking on the real uncertainty – primary carriers will set caps around what they think they can afford and pay premiums to have re-insurers pick up the rest. It does appear that reinsurance companies will have to write some big checks to pick up the primary carriers’ excess losses. But even with the terrific amount of damage on some of the most expensive real estate in the U.S., the global reinsurance markets can absorb the damage easily.

Case in point: Munich Re (Deutsche Börse – MUV2) a giant reinsurer, actually raised its expected target profits in the wake of Sandy – and suggested it may even increase its dividend this year. It expects about a 3 million euro loss from Sandy, – right around what it planned for the storm season, or possibly even less. It’s trading very near its 52-week high.

Everest Re (NYSE – RE) is down slightly from its October highs. But it’s still trading higher than it was all summer.

Swiss Re (OTC – SSREY), the world’s second biggest re-insurer, is trying to figure out what to do with all its profits for the year. Despite Sandy, storm losses for the year were much smaller than it anticipated. It announced it may cut a special dividend this year.

For all its devastation, Sandy was very much in line with the risk levels that insurers and reinsurers expect. It hurts, but they’re in the business of taking the pain. The real economic devastation will be borne by those who gambled by going without flood insurance and lost.

Flood Insurance Outlook

Longer term, insurers are hurt by low interest rates, which slow the earnings they can get on the “float” – that is, premiums taken in that have not yet been paid out in claims. Insurers will also doubtless want to replenish their reserves from Sandy expenditures. The combination indicates that the overall insurance market may tighten somewhat, meaning the low interest rates and Sandy claims experience may combine to lead insurers to raise premiums.

However, consider what happened after Hurricane Irene; demand for flood insurance after Irene tripled.  Because northeastern residents developed an awareness (and fear) of extreme weather, and went out to buy additional insurance against the next storm, it hypothetically provides a rich source of new premium to both primary insurers and the reinsurers who back them up.

That’s no consolation to those who lost their homes and for those who lost loved ones in the disaster, and our hearts are with them in the wake of Sandy. But the rest of the country should take notice.  Floods are economically devastating, and they routinely cause damage greater than anything a typical American family can bear themselves without some risk spreading through insurance. Thousands of homeowners are learning that painful lesson now, and we hope to not have to be taught that lesson again anytime soon. Houses in a flood zone have an actuarial 1 in 4 chance of incurring a flood within any given 30 year period. That’s a gamble most Americans cannot afford to lose. If you live in a coastal area, and you don’t have flood insurance, get it.