On Saturday February 27, a massive earthquake just offshore in southern Chile killed hundreds of people and caused extensive property damage. During the same weekend, a major windstorm in Europe named Xynthia hit France, Portugal, and Spain, spawning significant property losses and death halfway around the world.
Insurance companies underwrite diverse exposures on their own books, but theoretically uncorrelated risks can sometimes result in losses arriving right on top of one another. That is why reinsurance companies exist, to provide a means whereby insurance companies redistribute and diversify exposure to large single catastrophic events, as well as exposure to the potential coincidence of multiple unconnected events.
The first-quarter 2010 catastrophes led to significant losses for the insurance industry. A recent report from global reinsurance broker Willis Re estimated the first-quarter losses could set a record for first-quarter insured catastrophe losses. Then, on April 20, an oil rig called Deepwater Horizon suffered an explosion in the Gulf of Mexico. The rig caught fire and sank, sparking a massive oil spill. The ultimate costs of this spill remain uncertain, but insured losses look at least as large as those resulting from the windstorm Xynthia.
While the recent months have been an active interval for catastrophes, to date the losses appear manageable in the aggregate, as well as for most individual firms that we follow.
The 2010 Chilean Earthquake
A large earthquake in Chile is not a huge surprise, which is why there is demand for earthquake insurance in that country. In fact, Chile endured the 20th Century's largest earthquake in 1960. Measuring 9.5 on the Richter scale, this disaster killed more than 1,500 people and spawned a tsunami that caused extensive damage as far away as California, Hawaii, and Japan.
It takes time to develop loss estimates after a natural disaster, and the final cost of the Chilean earthquake is yet to be determined. But current estimates are putting the total insured loss at roughly $8 billion to $10 billion.
European Windstorm Xynthia
Europe is regularly pummelled by windstorms germinating over the Atlantic Ocean and hitting the mainland. On the weekend of February 27-28, more than 50 people died in France, Germany, and Spain when windstorm Xynthia arrived with hurricane-force winds. An estimated one million homes lost power when the storm was at its worst. Authorities in France described the windstorm as the worst the country had seen since Lothar and Martin arrived in 1999.
European insurers have a cooperative called PERILS that compiles industry data. In early April, this organisation released its initial estimate of insurance industry losses from Xynthia, totalling $1.7 billion. Subsequent estimates from insurers and catastrophe modelling firms have suggested insured losses from this storm could run as high as $2 billion. PERILS will issue a revised estimate of industry losses in late May, but its initial estimate for losses from European windstorm Kyrll in 2007 proved reasonably reliable. That storm produced an estimated $10 billion in total industry losses.
The Xynthia losses are probably going to run in line with the annual average for losses produced by these European storms, well below some of the worst. Damaging European windstorms aren't all that extraordinary in one sense, as they tend to arrive every year. The losses for Xynthia, by themselves, are well within the range and capital capacity of the insurance industry. Losses are going to be significant, but thus far look to be well-absorbed by insurers and the network of reinsurers that stand behind them. In 2008, windstorms Ike and Gustav arrived in the Gulf of Mexico and produced roughly $20 billion in insured losses, but were managed and paid for without significant disruption, even though the industry was challenged simultaneously by stress on capital positions stemming from investment losses during the worldwide financial crisis.
The Deepwater Horizon Oil Rig Disaster
On April 20, 2010, an oil rig the size of two football fields suffered an explosion, caught fire, sank, and is now resting at the bottom of the Gulf of Mexico. A large oil spill followed, threatening to be one of the worst environmental disasters ever.
Estimating the total losses from the spill is a fluid situation. There are sharply conflicting estimates of the physical characteristics of the spill, with widely varying estimates of the amount of oil spilling into the Gulf every day. In turn, anticipating the effectiveness of remediation efforts has proved difficult, given the failure of an initial attempt to cap the leakage. On top of the physical uncertainties, complex legal issues surround the assignment of liability, and many insurance industry participants are unwilling to estimate their own exposure or even total industry exposure. Thus far, however, those willing to hazard an aggregate estimate suggest insured losses could total several billion dollars. Swiss Re, one of the world's largest reinsurers, has estimated total insurance industry losses from this event could run in the wide range of $1.5 billion to $3 billion.
There is more uncertainty involved with developing an expectation for total insurance industry losses from this event than the Chilean earthquake or Xynthia. But again, at this stage, the losses from the Deepwater Horizon disaster look manageable for the world's insurance industry, and there are few signs today that any one individual insurer has taken an unmanageable hit.
Overall Losses Look Manageable
While the numbers in the discussions above are certainly large, they look very manageable in the context of the reinsurers' capital. It may have been a record first quarter, but the first quarter is not as significant as the third quarter in catastrophe loss calendars, and the industry has taken much larger hits in recent years from hurricanes. The last time we had a truly bad quarter for the reinsurance industry was in 2005, when hurricanes Katrina, Rita, and Wilma spelled devastation in much of the Southeast US. Total insured losses from those 2005 hurricanes came in above $50 billion, and prompted significant new entries in reinsurance markets coupled with more careful underwriting and contracting practices among reinsurance companies.
Some Context for our Reinsurance Coverage List
We follow nine publicly-traded reinsurers at Morningstar. These firms have more widely ranging primary insurance businesses, and the list also makes an important exception in the case of conglomerate Berkshire Hathaway. The limited impact of the dramatic catastrophic events in the first quarter of 2010 for the firms we cover can be seen in light of the annualised growth in book value per share for each of these companies in the table below. Book value per share growth is driven by a number of factors in any given quarter, and continuing recoveries in investment portfolios coupled with relatively good underwriting results elsewhere offset those catastrophe losses. Book value per share can be quite sensitive to heightened catastrophe losses, but it rose in the first quarter for seven of the nine reinsurers that we follow, with an average annualised increase for those firms of 15%. Moreover, this occurred in a record first quarter for catastrophe losses.
The table above shows how the generally positive first-quarter 2010 results came on the heels of resilient financial performances for most of these companies in the past three years. The table includes book value per share data for 2007, 2008, and 2009, with each of those endpoints indexed to 2008 = 1.00. The year 2008 included not only an elevated catastrophe loss period, but also the dramatic storms in capital markets that wreaked havoc and losses for many investment portfolios in the insurance industry. With the investment recovery and benign catastrophe loss year in 2009, book value per share at year-end 2009 was higher than it was heading into 2008 for six of these nine companies, while basically unchanged for one of them (Munich Re). Two of these nine firms--Swiss Re and XL Capital--took outsized losses in 2008, and these two firms also posted relatively high growth in book value per share in the first quarter of 2010 despite their heightened underwriting losses.
Reinsurance premium rates have been softening, with improvements in industry capital positions amid the recovery in investment portfolios being one source of increased supply and lower rates in the past year. The world remains a hazardous place, however, and insurance buyers' sensitivity to the risks of hurricanes, earthquakes, and other natural disasters as well as 'man-made' losses could couple with rising economic growth to lay the basis for some stabilisation if not firming in reinsurance rates, and improved industry return prospects in the years ahead. While we are not currently recommending any of the reinsurers as a 'buy' given the rally in their share prices in the last year and the high uncertainty ratings we assign these complex companies, some of our long-favoured stocks in this field remain our favourites today. They include RenaissanceRe, a special catastrophe reinsurance specialist with a long record of producing significant growth in shareholder value.
