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COMMENT: Hurricane Katrina five years on
27 August 2010
With the fifth anniversary of Hurricane Katrina hitting New Orleans on August 29, Reactions' editor Michael Loney reflects on how the insurance and reinsurance market has changed since then.
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With the fifth anniversary of Hurricane Katrina hitting New Orleans on August 29 it is a useful time to reflect on how the insurance and reinsurance market has changed since then.
I remember Hurricane Katrina very well. I had just moved to New York from London to be Reactions’ US editor two weeks before it struck and my introduction to cable news networks was being glued to around the clock coverage as the horror unfolded in New Orleans and elsewhere, with thousands instantly made homeless and having their lives ruined by the unforgiving storm.
It was obviously a big deal for insurers as well, causing the biggest ever insured loss from a single event. The insured losses caused by Katrina and the New Orleans flood exceed $45.9bn (adjusted to 2010 dollars). This amount is almost double the amount of insured losses from the second most costly natural disaster in the US, Hurricane Andrew, which cost $24.1bn.
The Property Casualty Insurers Association of America (PCI) recently released a white paper that showed the lessons learned from the event continue to have a profound effect on the industry. Hurricane Katrina created important opportunities for the property/casualty insurance industry to assess the ways in which it prepares to respond to natural catastrophes.
Despite negative earnings immediately after the storm, the property/casualty insurance industry has emerged from the Katrina experience on solid footing, says PCI. Policyholder surplus reached its peak of $537.2bn at year-end 2007. And while the natural catastrophes of 2008 and the financial crisis caused surplus to dip to $474.7bn, it rebounded at year-end 2009 to a healthy $531.6bn.
However, PCI noted that Katrina’s effects on insurers include: a greater awareness of the importance of loss mitigation; a better ability to cope with and minimise business disruptions; more flexible disaster recovery plans; the use of more advanced technologies to improve customer communications; heightened awareness of the need to educate the public on the need for flood insurance; and the continued development of catastrophe models.
“The lessons learned from Katrina have helped to improve loss mitigation and disaster recovery efforts over the last half decade,” said David Sampson, president and CEO of PCI. “Additionally, while the insured losses were significant, nearly $46bn, the property/casualty insurance industry has emerged from the Katrina experience on solid footing and today it is in a very strong position to fulfil its obligations to stakeholders and provide the necessary coverage to help fuel economic recovery after a major storm. Whenever and wherever storms occur, property and casualty insurers provide homeowners, business owners and drivers with the peace of mind that comes from knowing that their insurer will be there to provide a helping hand after the wind blows.”
The Katrina experience also moved two products developed in response to catastrophic events into the big time. Two products that have aided in mitigating risk and obtaining financial protection against future losses are catastrophe bonds and reinsurance sidecars – both as a vehicle for insurers and reinsurers to add risk-bearing capacity and for investors to gain potential profits.
Cat bonds had been around since the mid-1990s but their use up until 2005 had been restricted to a few innovators and dabblers. After Katrina, with traditional reinsurance pricing rocketing and supply tightening, cat bonds became a mainstream alternative for those desperate for capacity. According to Guy Carpenter cat bond issuance hit $4.7bn in 2006 and then $7.0bn in 2007 – up from a mere $2.0bn in 2005 and $1.2bn in 2004.
In Katrina’s wake sidecars also became the must-have fashion accessory for insurers and reinsurers looking to bulk up on the now-attractively-priced catastrophe business. So much so that some now predict that after the next big event it will be a wave of sidecars, and not fully-fledged start-ups, that will emerge.
But the interesting thing about Katrina is that – even though it was a loss far beyond that experienced by the industry up to that point – it did not have a long-term effect on pricing and firms’ approach to the business. To be sure, the losses hurt, but the industry had an enviable surplus at the time and was able to absorb the hit pretty well. Months of hand-wringing and finger pointing about why risk models had not told insurers and reinsurers that they could also be hit for large losses from flooding also followed. As did a backlash from politicians looking to make capital out of insurers refusing claims, even though the industry did an admirable and speedy job of paying out in the vast majority of cases.
But the effect on pricing was extremely short-lived, with a spike for a year and then quickly coming down again. The industry took the event in its stride, which is quite remarkable and something for which it should be commended.
So five years on we find ourselves in a similar situation. The industry is sitting on masses of excess capital and pricing is insipid. An even more amazing fact is that it would likely take an event or a series of events even larger than Katrina to move the needle on pricing to a large degree. It is both heartening – showing the strength of the industry right now – and depressing – showing just how far the market is from the hardening prices that insurers and reinsurers so crave.