Stormy weather may mean sunny skies for insurance stocks

Published: Saturday, Sept. 25, 2004 7:37 p.m. MDT
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Insurance companies and their shareholders are not the most important consideration when a savage hurricane slams down on a community with 135 mph winds.

People, homes and services matter the most. Yet the aftermath of such devastation dramatizes what investing in property and casualty insurance companies is all about.

These insurers exist in the first place because bad things do happen from time to time. The best-managed of them handle this risk well and are profitable investments for long-term stockholders. In addition, shares of specialized firms that provide the insurers with backup coverage for the biggest of catastrophes also offer potential.

In the short run, Mother Nature holds all the cards. Catastrophes can drive up prices of insurance stocks as investors anticipate higher premiums will be charged in the future, as happened after the 9/11 terrorist attacks. Or, they can pull down the stock prices if the insurer doesn't seem adequate financially and losses are enormous.

"It is never the insurance companies paying for the losses, but rather clients that will pay for those losses through higher premium levels," explained Bijan Moazami, managing director with Friedman Billings Ramsey in Arlington, Va. "Tens of billions of dollars in losses are generally a positive for the industry rather than a negative."

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The property and casualty insurance industry was caught napping in 1992 when Hurricane Andrew caused $20.3 billion in insured losses, adjusted for inflation. Realizing its mistake, the industry had battened down its financial hatches well before Hurricane Charley inflicted an estimated $6.8 billion in insured losses, Frances $2 billion to $4 billion, and Ivan $4 billion to $10 billion.

First of all, the insurers are in a stronger capital position than they were a decade ago and have more money to cover their costs.

"If you assume these 2004 hurricanes in aggregate will be similar to Hurricane Andrew, the loss from Andrew in 1992 represented a very meaningful 10 percent of the capital of the industry, while today it would represent about 5 percent," said Michael Paisan, principle with Legg Mason Wood Walker in New York. "The capital base of the insurance industry has grown dramatically the last few years because profitability has been good."

Secondly, they have more financial backup when they need it. In Florida, the state-run Hurricane Catastrophe Fund that was created after Andrew's devastation provides reasonably priced reinsurance coverage for insurance firms doing business in that state. The fund is financed by policyholder premiums.

Reinsurance is a form of coverage that an insurance company obtains as a hedge against catastrophic loss when claims exceed a specified amount. Insurers concerned about the unpredictability and potential for damage of hurricanes, particularly firms operating in states other than Florida that have no dedicated hurricane fund, buy private reinsurance coverage.

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