Reading the Tea Leaves

The North American insurance industry currently faces a high-stakes, $40-billion to $60-billion question: Will the destructive winds of Katrina, Rita and Wilma blow the industry into the grip of an enduring hard market?

Several ratings agencies note that thanks to a hard market in the early part of the new millennium, the fierce 2005 hurricane season couldn’t have hit the U.S. insurance industry at a more solvent time. The industry posted underwriting profits of $13.2 billion during the first two quarters of 2005 and a healthy net income of $32.1 billion during the first half of 2005. Ratings agencies say – caution, really – that these profits reflect gains made during the hard market that existed prior to 2003.

Just what kind of season has 2005 been? Well, all of the impressive financial gains will likely be cancelled out as a result of losses posted in the wake of Hurricanes Katrina, Rita, and Wilma. At this point, Katrina itself is on track to double the $15-billion insurable damage losses inflicted by its deadliest rival, Hurricane Andrew.

Ratings agencies predict stable financial outlooks for many insurance companies in the face of such huge losses; at the same time, they have placed a fair number of reinsurers on CreditWatch with negative implications. It is safe to say the industry’s financial situation is listing somewhat, despite all reassuring public statements to the contrary. Perhaps Aon Re president and CEO Gregory Case best characterized the mood when he was recently asked at Aon Re’s 2005 Rendezvous in Toronto what the industry would do in the event of yet another natural disaster during this year’s hurricane season. Using understated humor to make his point, Case said only that it would be “not good” for the industry to see another devastating Category 3 or 4 storm this season. Enter Hurricane Wilma, a Category 3 storm now buffeting the Florida Keys, causing AIR Worldwide modeling to predict damages between $6 billion and $9 billion as of press time.

So how is it that ratings agencies expect the industry to weather the storms without much difficulty? Simple. They note the industry is reaping the benefits of a hard market during the early 2000s, during which time underwriting was disciplined and pricing was high, as Moody’s put it in a recent outlook. One industry news agency quoted a senior Fitch executive as saying he believed the industry could make up for the loss of capital as a result of Katrina over the next 12 to 18 months.

In the short term, ratings agencies and other industry analysts expect reinsurers to “re-capitalize” – a fancy way of saying reinsurers will look for ways to make up for the money lost as a result of paying out hurricane-related damage claims.

The prevailing wisdom among ratings agencies is that many reinsurers – particularly U.S. reinsurers that were hardest hit by the storms – will hike their pricing and explore exemptions for certain classes of coverage. Such moves – which sound very much like the recipe for a hard market — will broadly affect the North American market, because insurers hit with higher reinsurance rates will likely respond with pricing increases and tighter coverage of their own, according to Celent, a Boston-based financial services research firm.

Hard markets are good, let’s keep them going forever, ratings agencies say. That is why, despite signs of a predicted hard market, ratings agencies such as Moody’s, A.M. Best, Fitch and Standard & Poor’s are all sounding alarm bells. “Despite the solid results posted for the first six months of 2005, A.M. Best Co. is concerned with the reduction of year-over-year premium rate increases that persisted for consecutive reporting periods since 2003 and gave way to premium decreases across most lines of business and sizes of accounts in 2005,” the company recently reported. Standard & Poor’s expressed similar pessimism, saying current soft-market practices would ultimately betray the burgeoning hard market.

So what will be the enduring impact of the hurricanes: A hard or soft market? The prize money for answering the question correctly is increasing by the hurricane.