Assessing the damage
Insurance executives say losses could affect rates, coverage

by Joan Tupponce
Virginia Business
December 2005

A boxer might call it a one-two-three combination, a series of three quick punches that leave his opponent reeling. In this case, however, the event wasn’t a boxing match but a hurricane season that landed blows to the insurance industry with Katrina, Rita and Wilma.

The 2005 hurricane season may be over, but it will not be forgotten. The insured losses from Hurricane Katrina alone are estimated at $40 billion to $60 billion, more than losses from 9/11. Insured losses from Hurricanes Rita and Wilma may add another $20 to $30 billion, bringing total estimates close to $90 billion.

“The storms of 2005 are the largest natural disasters we have faced in modern times,” says R.C. Moore, principal and managing partner for Tabb Brockenbrough & Ragland, an independent insurance agency in Richmond. “The estimates of $90 billion represent 10 percent of the surplus [or equity] of the insurance industry.”

The reinsurance market may suffer the most damage. Insurance companies contract with reinsurers to transfer responsibility for many of their largest risks. To recoup their losses, reinsurers may raise their rates and reduce capacity, the amount of coverage that an insurance company can buy. These increased costs and capacity shortages eventually could trickle down to commercial clients, leaving them with higher rates and reduced coverage.

“The question is: What will happen to the reinsurance market?” says Bob Bradshaw, executive vice president of Independent Insurance Agents of Virginia. Bradshaw believes Vir-ginians will see minimal short-term effects from the losses. In the long term, he says, rates will depend on a number of factors, not only losses from the hurricanes, but also on the fate of the Terrorism Risk Insurance Act , due to expire at the end of this year. The law was enacted after 9/11 to provide insurance against terrorist acts. “Commercial business in the coastal area of Virginia may see some natural increases [in insurance rates], but it has been difficult for the coastal market to obtain insurance anyway,” says Bradshaw.

The ripple effects from the reinsurance market will become clear when reinsurance treaties (policies for insurance companies that cover the insurer’s book of business) are evaluated. Most treaties are evaluated twice a year. “That is going to be a telltale sign based on what the reinsurance carriers feel they might need,” says Priscilla G. Hottle, president of USI D.C. Metro in Falls Church.

Reinsurance rates will probably escalate, predicts Larry Loving, resident managing director for Aon Risk Services Inc. of Virginia. “If they have a reinsurance capital base of $160 billion and the hurricanes cost $20 billion, they can regain their base quickly if they increase the cost [of reinsurance],” he explains.

Even before this year the reinsurance market was taking a beating, says Quentin van Marcke de Lummen, senior vice president, property practice leader for the Virginia operations for Marsh USA Inc. Eight of the 10 most expensive disasters in U.S. history have occurred in the last four years, and seven of the nation’s 10 most expensive hurricanes have occurred in the last 13 months. And losses don’t take into account other catastrophic losses worldwide, such as last year’s tsunami in Asia.

“In today’s marketplace you have fewer and fewer reinsurers, so these losses are hitting the same reinsurers over and over again,” the Marsh executive says. “They will need to make their money back [which could result in] an increase in their rates and premiums.”

He says that insurance companies will be faced with the choice of absorbing the extra cost and reducing their profit margins or they can pass the added cost along to policyholders. Because of the dramatic losses incurred this year, he believes insurance companies will pass some of the increases along. “The question is how much will they pass along,” he says.

If reinsurers reduce capacity, insurance companies may not be able to provide businesses with the same amount of coverage they have offered in the past. “[Right now] we don’t know how extensive that will be. Capacity is an issue we all have to be concerned with. Businesses who want to continue capacity might have to go to multiple insurance companies to buy the same amount.”

While the losses from Katrina, Rita and Wilma are unpreced-ented as a whole, Tony Markel, president and COO of Markel Corp. in Richmond, doesn’t believe the industry will be thrown into a financial tailspin.

“It would have been a bang-up year [in the industry] if it hadn’t been for the storms,” he observes. “It was a defining event that will be negative financially in the short run and positive in the long run. It brought the industry back to reality. It reminded the industry of its vulnerability and the necessity for adequate risk selection and pricing. It should put a stop to what was fast becoming an overheated, competitive environment.”

The losses also shook up the industry in other ways, Markel adds. “Clearly a lot of companies were dependent on catastrophe models software packages that can estimate losses.” Now the accuracy and validity of this software are being questioned.

Some storm victims and their supporters are trying to get insurance companies to recoup losses that weren’t intended to be covered. If successful, these efforts could have long-term effects on the insurance industry. “There is a public outcry to help those affected by these events which often leads to public policy pressure to get claims settlements against the insurance industry where coverage did not exist,” says J. Daniel Cook, executive vice president of Manry-Rawls Corp. in Franklin “While this may pay short-term dividends to some current victims, it will only lead to stronger policy language and reductions of coverage in the future as the insurance industry is forced to respond in order to be able to manage future losses.”

Unlike 9/11, the hurricanes hit when most insurance companies were financially strong. “The losses from 9/11 couldn’t have come at a worse time,” says Walker Sydnor, president of Scott Insurance in Lynch-burg. The market, at the time, was soft, resulting in lower rates and, in turn, lower insurance revenue. “Companies were hurting. Then 9/11 happened and companies were doubling rates. These events are different because we have had two to three exceptional years. I don’t think you will see the knee-jerk reaction you saw after 9/11.”

One positive reaction is the push to develop plans that will prepare businesses for future catastrophic events. “We’re spending more time working with clients on risk management issues and preparing Virginia businesses for these types of events,” Moore says.

The Independent Insurance Agents of Virginia plans to convene a meeting of insurance agents, insurance companies and government agencies to discuss disaster planning. “Virginians have dodged a couple of bullets. Let’s learn what’s happening,” Bradshaw says.