After the storm

When Hurricane Andrew ravaged southern Florida in 1992, the global insurance industry struggled to absorb a then-record insured loss of $15.5 billion. Eleven U.S. insurance companies went bust, and eight reinsurers were founded in Bermuda to underwrite natural catastrophe risk. Then in 2001 the September 11 terrorist attacks on New York and Washington dealt an even bigger blow. With losses hitting $20 billion, investors poured an unprecedented $28 billion in fresh capital into the industry, founding a new generation of insurers and reinsurers to profit from a sharp rise in insurance rates.

Now, for the third time in a little over a decade, the industry is counting the cost of yet another cataclysmic event. Insured losses from hurricanes Katrina and Rita are expected to reach as much as $60 billion, and Hurricane Wilma looked set to add to anywhere from $2 billion to $10 billion to that total after its run through

Florida late last month. By late October losses registered amounted to $34.4 billion, and more than 1.6 million claims had been filed in six states, according to the Insurance Services Office. Many areas have been changed almost beyond recognition, with much of New Orleans destroyed by flooding and the Mississippi Gulf Coast devastated by winds and water.

The insurance industry, by contrast, remains very much intact this time. Storm losses will wipe out expected profits at many insurers this year, but none are in danger of failing. The amount of fresh capital raised, roughly $6 billion as of late last month, has been modest compared with investment after previous disasters, with most of the money going to established players rather than new entrants.

As a result, most executives and analysts expect rates to firm up, with some business lines enjoying premium increases of 20 percent or more. That would be a welcome change for insurers after the double-digit decline in rates seen over the past year.

"Bottom line, we do not believe that the incremental [capital] raised thus far and what we expect in the near term will derail a better reinsurance pricing," Thomas Cholnoky and Jaqueline Cheungat, analysts at Goldman, Sachs & Co., wrote in a recent report. They estimate that the industry will raise less than $10 billion in fresh capital, a fraction of the storm losses.

The biggest rate increases, not surprisingly, are expected to be seen in the areas hardest hit by Katrina and Rita. Reinsurance premiums on offshore oil and gas facilities in the Gulf of Mexico, and some marine risk, could rise as much as 100 to 200 percent, says Michael Butt, chairman of Axis Capital Holdings, a Bermuda-based reinsurer. Reinsurance rates for Gulf Coast residential and commercial property are seen rising by about 40 percent, executives and analysts say.

Casualty rates are expected to rise the least, with estimates ranging from single-digit increases to as much as 20 percent. Companies that provide retrocession insurance -- that is, insuring the reinsurers -- are expected to enjoy rate increases on the order of 20 percent-plus.

The industry's ability to weather a storm like Katrina reflects dramatic improvements in risk management and capital strengthening that companies have made over the past decade.

"The insurance industry circa 1992 would be almost unrecognizable today," says Hemant Shah, president and CEO of Risk Management Solutions, which provides risk modeling for insurance companies. "There has been a whole string of catastrophic events that, alongside the increased use and adoption of risk models and exposure-based risk management practices, have made insurers that much more aware about their risks and that much more able to plan for appropriate levels of diversification.''

Still, many executives remain wary about the outlook. They note that insurers would have struggled to cope if Rita had caused anywhere near as much damage as Katrina, as it briefly threatened to do.

Companies face an uneasy sort of equilibrium, says Geoffrey Bromley, chairman of Europe and Asia for Guy Carpenter & Co., the reinsurance broking subsidiary of Marsh & McLennan Cos. "We have the ability to withstand this biggest-ever loss and trade on reasonably soundly, yet were that second hit to have occurred, we would have, perhaps, been in a state of relative disarray," he explains.

Before the hurricanes hit, 2005 was shaping up to be the industry's most profitable year in more than a decade. U.S. insurers posted record profits of $30.9 billion in the first half of 2005, up 29 percent from a year earlier, according to the Insurance Information Institute, a New York­based trade association. The industry's consolidated surplus -- the amount it could use to pay claims if needed -- increased to $412.5 billion on June 30 from $398.8 billion at the end of 2004.

"The industry will weather this crisis just fine," says Bryon Ehrhart, president of Aon Corp.'s reinsurance brokerage, Aon Re Services, in Chicago.

The industry's financial strength notwithstanding, however, the storm damage has been massive. Roughly 70 major insurers and reinsurers have announced combined losses of $21.6 billion to $24.2 billion from Katrina and Rita. That tally is expected to climb further in the weeks ahead as more claims roll in from those storms and from Wilma.

Among the hardest hit was Lloyd's of London. The market estimates its losses from the first two U.S. storms at $2.55 billion. Most of those losses come from insurance and reinsurance policies on onshore and offshore energy facilities, property catastrophe, business interruption and marine cargo.

Barring another major loss, Lloyd's should post a profit for the full year, and none of its syndicates, or operating companies, are expected to have to draw on the market's central fund, says chief executive Nick Prettejohn. Analysts forecast that Lloyd's pretax profits could exceed £1 billion ($1.8 billion) for the full year, compared with £1.4 billion in 2004.

Advent Underwriting, which operates as Lloyd's syndicate 780, has reported U.S. storm losses of $55 million, equivalent to 32 percent of shareholder funds. But executive chairman Brian Caudle says the firm expects to benefit from higher premiums in the new year. "We are quite excited, as there are some opportunities available to us now," he tells Institutional Investor. Wellington Underwriting, one of the leading Lloyd's insurers, posted hurricane losses of $125 million, or 15 percent of shareholder funds, but it too expects to benefit from an expected upturn in premiums. The company will increase its U.S. underwriting capacity by 20 percent in 2006, to $1.4 billion.

The losses reveal significant shortcomings in the risk modeling that insurers have increasingly relied upon. Since Hurricane Andrew, companies have been collecting data in an effort to estimate potential losses from future catastrophes. Models proved insufficient to foresee the extent of the losses from the 2001 terrorist attacks, however; with Katrina, most simulations failed to anticipate the extent of the flood damage in New Orleans and on the Gulf Coast, as well as the business interruption costs caused by the city's prolonged closure.

"Organizations are already finding that they have much larger losses than they would have anticipated in an event like this," says Ken LeStrange, CEO of Endurance Specialty Holdings, one of the firms set up in the wake of the September 11 attacks. "And that is marginally due to the weakness of the models."

Modelers like Shah have gone back to their drawing boards, and companies have been agonizing over what went wrong. Insurers are updating their models to reflect a wider range of secondary risks, such as flooding from dams breaking during an earthquake, executives say. They are also likely to be more conservative in writing new policies.

The risk that a catastrophe will trigger losses on several different lines of insurance, such as home, life and business interruption -- a factor known as accumulation -- is "less well known and less definable, and that is a problem," says Robert Cooney, chairman and chief executive officer of Max Re Capital, a Bermuda-based reinsurer set up by hedge funds in 1999. Considering that the severity and frequency of storms may intensify in coming years, Cooney says, companies will look to protect themselves by diversifying their risk by geographic area and product line, tightening up contract language to exclude some risk or simply reducing their underwriting.

For some companies, however, the massive storm damage represents an opportunity.

So far more than a dozen companies have raised a total of $5.5 billion in fresh capital, led by Bermuda-based Ace Ltd., which raised $1.5 billion with a secondary stock offering. The company launched a new subsidiary, Ace Energy, last month to provide property/casualty insurance to the U.S. energy sector, including on- and offshore oil and gas facilities and electrical power plants.

"With the devastating impact on the energy markets caused by the spate of recent hurricanes, there is a heightened need for more and better risk management solutions for the U.S. energy market," says John Lupica, president and chief operating officer of Ace USA.

Another firm that went back to investors was Axis Capital, which raised $250 million with an issue of preferred shares. Chairman Butt declines to say how the company would deploy the funds, but he has plenty of experience in spotting opportunity in the wake of disaster. He was part of the group that set up Mid Ocean Reinsurance in the aftermath of Hurricane Andrew, and in 2002 he joined Axis, which was formed after the September 11 attacks.

One new company appears set to enter the market. Validus Reinsurance is being established in Bermuda with an expected $1 billion of capital to underwrite property and catastrophe risk, sources close to the company say. The outfit will have backing from a new private equity fund, Aquiline Capital Partners, founded by Jeffrey Greenberg, who resigned as chairman and chief executive of Marsh & McLennan Cos. last year following investigations of alleged bid-rigging by New York State Attorney General Eliot Spitzer.

The amount of new capital likely to enter the market and the impact it will have on premiums are the subject of vigorous debate in the industry. Many executives believe rates will harden because the amount of capital raised so far remains modest -- less than one fifth of what flooded into the industry after the September 11 attacks.

Robert Hartwig, chief economist at the Insurance Information Institute, estimates that as much as $15 billion in new capital could be raised eventually, which he fears would depress rates.

"The flood of capital will have a tempering effect on reinsurance pricing and primary insurance pricing," says Thomas Upton, an insurance credit analyst at Standard & Poor's in New York.

Another issue clouding the outlook for rates is the underwriting cycle. Unlike in 1992, when Andrew hit the market after a lengthy period of declining rates, the industry this year was just coming off a hard market. U.S. premium income rose at an annual rate of 9 to 10 percent from 1999 to 2004, according to the Insurance Institute's Hartwig, so the potential for further increases is uncertain.

The decline in premiums seen in 2005 "will likely reverse selectively, with particular hardening in rates for property catastrophe and property per-risk reinsurance along with energy and marine," says a report by Tillinghast, the insurance consulting arm of consulting firm Towers Perrin.

Will the rate increases restore the industry's fortunes? A lot depends on what Mother Nature does. Many scientists say weather patterns are changing, with a greater frequency of more-severe storms. The recent experience is certainly sobering. Katrina, Rita and Wilma came in the wake of an active 2004 hurricane season in which four large storms caused a combined $25 billion to $30 billion in insured losses.

"We have had two seasons in a row now where we have had multiple major storms within just a few weeks of each other," says Hartwig. "And that may become the norm rather than the exception in the years ahead. Certainly, current rates do not adequately reflect that level of risk."