Tillinghast: Hurricane Katrina Will Cost Record-Setting $40-$55B for Privately Insured Losses

October 6, 2005

Hurricane Katrina is expected to result in $40 to $55 billion in private insurance payments, according to a new white paper developed by the Tillinghast and Reinsurance businesses of Towers Perrin. Hurricane Katrina: Analysis of the Impact on the Insurance Industry notes that the estimate allows for a significant “demand surge” (increase in local market costs due to vastly increased demand), but does not include specific Hurricane Rita event costs.

“Katrina will displace the September 11th terrorist attacks as the single most expensive insured occurrence in the U.S. to date,” said Patricia Guinn, managing director. “The consensus estimate for September 11th insured losses is approximately $35 billion; Hurricane Andrew produced $20 billion in insured losses. Perhaps the most worrisome lesson from Katrina is that losses measured in the tens of billions are becoming much more commonplace due to the growth in coastal property concentrations. All sectors of society — including insurers — must prepare for this new reality.”

Tillinghast expects that individual lines of business will have the following losses:

* Personal lines: $15.2 to $19.3 billion
* Commercial lines: $19.7 to $25.3 billion
* Marine and Energy: $4 to $6 billion
* Liability: $1 to $3 billion
* Other: Up to $1 billion.

“We expect the insurance market to react to these losses somewhat differently than it did following Hurricane Andrew and September 11th,” observed Stephen Lowe, leader of the firm’s global P/C insurance consulting practice. “Now, the market is coming off of a three-year hard market with reasonable profitability. Although softening had started to appear, we believe this trend toward lower pricing will reverse selectively, particularly in property catastrophe and property per-risk reinsurance, along with energy and marine.”

Towers Perrin’s white paper suggests a number of critical implications, including:

* Who will bear the insured loss?: Tillinghast expects the reinsurance market to absorb +/-50% of the losses from Hurricane Katrina, significantly more than in 2004 when reinsurers bore 20% of the losses from the four hurricanes that hit Florida. Direct insurers will retain almost all of the remainder of the total insured loss from Hurricane Katrina; only 1% to 3% will be borne by the capital markets through catastrophe bonds and insurance derivatives.
* Will Katrina trigger new market entrants?: “Katrina, unlike Andrew and September 11th, will be more of an income statement event than a balance sheet event,” said Bill Eyre, leader of the firm’s Reinsurance business. “While some companies will lose significant amounts of capital, most will be able to absorb their loss within 2005 earnings. The recent hard market and current global reinsurance capacity do not suggest a compelling opportunity for additional start-ups backed by venture capital.”
* Pressure for stronger capitalization: Katrina and Rita have caused rating agencies to take a careful look at plans to replenish capital. Tillinghast expects rating agencies to urge companies writing catastrophe exposed business to improve risk management systems and controls, and to provide stronger capitalization to support increased risk.
* Risk management to become CEOs’ top concern: Insurance leaders will take a hard look at the mix of risks in their portfolio and reinsurance protections, focusing on further improvements to their geographic mapping and catastrophe models in commercial lines and business interruption exposures. This event will almost certainly cause a shift in the industry’s perception of what constitutes adequate reinsurance protection.
* 1960-99 hurricane lull coincided with massive build-up in Southeastern U.S. coastal properties: Following a lull during the 1960s-90s, climate data suggests that hurricane conditions in the Atlantic have returned to a more active phase. Hurricanes will be more frequent than public perceptions based on recent memory and could possibly be more severe. More importantly, the dramatic build-up in coastal property values that occurred during this lull will mean that we can expect much more significant losses when major hurricanes hit the U.S. Prior to Hurricane Hugo, insured losses from any individual hurricane had not exceeded $2 billion. Based on current exposures and climate conditions, we should expect a $20 billion hurricane loss roughly every 15 years.
* Expect public debate on the role private insurance plays in disaster recovery: Look for public dialogue around a number of concerns: 1) When it comes to natural disaster risk, should consumers pay the market price of their risk? 2) To what extent should rebuilding be constrained in catastrophe-exposed areas? 3) How do we address the disproportionate lack of insurance coverage among the poor? 4) Is mandatory integration of flood and earthquake coverage into homeowners policies needed?

A final question may revolve around what role, if any, the federal government should have in supplementing the insurance industry against very large losses. Is there a need to create a federal national disaster pool? “September 11th taught us that we don’t always know where the next loss will come from. Katrina taught us that we don’t always believe it, even when we do know,” said Lowe.

“Enactment of TRIA after September 11th was an extremely effective form of support that minimized disruption to the economy. As ‘mega-losses’ become more common, defining the proper obligations for the government, insurers and policyholders will be critical for all of us to weather the next storm,” concluded Guinn.

To read the white paper, log on to www.towersperrin.com/tillinghast after 4 p.m. EST on Friday, Oct. 7.

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