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Insurance
 THE VALUE OF CATASTROPHE
By Dan Ferris
(Excerpt from the Daily Reckoning)
"August 31 - I paid over $200,000 today in just one day. I found myself very emotionally upset at the severe destruction...  Everywhere that I stopped the people would rush around my car, which had the signs of my insurance company on it, asking for help. People were sitting outside of what was left of their homes, with their insurance company's names and their policy numbers written on whatever part of their home was left standing.
"September 20 - Many adjusters have left- unable to take the strain. Some did not last for more than a few days. It's like being in a 'war zone.' I must try and take a day off to relieve my stress.
"September 28 - I called my wife tonight... While I am talking to her, there is gunfire in the background. I hope she doesn't hear it. Yesterday, when I was doing a claim, 3 young men came up to the house with guns. The owner and I stood outside while they took away what was left in the house."
These words are from an insurance adjuster's personal journal of the devastation caused by Hurricane Andrew on August 24, 1992. At the end of his journal, hesays that when he gets home, he'll tell his wife everything he couldn't tell her while he was on the ground in Florida. Then she'll understand why he's going to buy a gun.
To this day, Hurricane Andrew is still the worst U.S. hurricane on record. Twenty-three people were killed. More than 135,000 homes were destroyed or damaged, 160,000 people were left homeless and 86,000 lost their jobs.
In just a few hours, the insurance industry lost every penny of premiums it collected in Florida during the previous 22 years, plus another $6 billion. Between 1970 and 1992, the insurance industry had taken in about $10.8 billion in insurance premiums in Florida. Andrew caused an estimated total of $26.5 billion in damages. Just over $16 billion of that was insured.
Hurricane Andrew is still fresh in the insurance industry's mind, too. To this day, State Farm won't insure many coastal Florida homes. The state insurance commission won't approve the 22% premium increase it needs to make it worth the risk. State Farm's biggest competitor, Allstate, did the same math. It also asked for a 22% hike in premiums but only got 15.7%. Allstate won't insure homes on the coast, and won't renew some policies.
Andrew was the largest insured loss in history until September 11, 2001. Losses from 9/11 are now estimated in the range of $40 billion - $50 billion. That's as much as 16% of a whole year's worth of insurance premiums for the entire United States insurance market ($300 billion), wiped out in a few hours.
Twelve insurance companies went out of business after Hurricane Andrew. I asked James Peavey at A.M. Best, the global insurance ratings firm, if his company kept a list of which insurance companies went out of business each year. They don't. But he did send me a report on the property/casualty insurers covering the years 1993 through 2002. Sure enough, 1993 was the second worst year on record for insurance insolvencies, with 1.2% of the industry going bust. The worst year on record was 2002, when 1.33% of the property/casualty insurers went bust.
Losses from 9/11 removed 38 companies from the market in 2002. We're not talking about a bunch of featherweights, either. Kemper Insurance Company was the seventh largest insurer in the United States; it closed and went out of business. Gerling Reinsurance was the seventh largest reinsurer in the world. Its property/casualty reinsurance business is in run-off. That means it's not taking on any new business. It's simply allowing its existing policies to expire. SCOR Reinsurance, the French company, was the 10th largest reinsurance company in the world, and was named Reinsurance Company of the year in 2000 by The Review - Worldwide Reinsurance magazine. Today, it's struggling to stay alive.
As if the lingering malaise of 9/11 weren't enough, there are more reasons to be repelled by the thought of investing in the reinsurance business. My favorite is that it's an awful business, measured by the industry's own favorite benchmark. The benchmark I'm talking about is a number called the combined ratio.
Insurance companies bring in money in two ways, insurance underwriting and investment income. The combined ratio gauges the profitability of insurance underwriting only. If you take in $1 of premium and pay out 90 cents of expenses and losses, your combined ratio is 90%. Obviously, anytime your combined ratio is below 100%, you are making money on your premiums. Historically, anything under 90% is superb - and exceedingly rare. Since 1975, the combined ratio for the entire property/casualty industry has been below 100% in only two years. The property/casualty companies are the ones who buy catastrophe reinsurance. If they have a hard time making money, you better believe the reinsurers do, too...  
The Reinsurance Association of America tracks the combined ratio for the entire reinsurance industry. Its latest report covers the 22-year period from 1981 through 2002. The combined ratio for the reinsurance industry never got below 101.5%. The average was 111.60%. In 1981, there were 120 reinsurance companies reporting to the RAA. It's no wonder that number has fallen steadily for 22 years, with about 40 companies reporting to the RAA in 2002. For a long time, the only way most insurance companies stayed in business was by investing in stocks and bonds. Now that risk-free interest rates are 4% and Aaa corporate yields are 5.5%, that's not going to be possible anymore. The bursting of the biggest stock market bubble in history in early 2000 didn't help.
Now you know exactly why, by any reasonable yardstick, reinsurance stocks are still cheap. The 9/11 catastrophe wrecked a bunch of companies. And insurance and reinsurance are just crappy, unprofitable businesses fraught with peril.
Who'd want to put their money into such a business? I would. Let me explain why you should, too. Forgive me if this sounds crass. But it's true. Disasters like Hurricane Andrew and 9/11 are exactly the type of big, ugly misfortune that creates excellent investment opportunities. And industries that appear to be universally reviled are often where the biggest profits lie.
Even before 9/11, property catastrophe insurance premiums were beginning to rise, after falling for 6 years in a row. When 9/11 hit, reinsurance premiums shot up 20% to 100% in the property catastrophe, marine and aerospace lines of business. Terrorism insurance today is like homeowners insurance for residents of coastal Florida - often impossible to get. With so many insurance companies either gone from the market or in trouble, the market is likely to remain hard, as they say in the insurance business, for at least a few years. A "hard" market is one where prices are rising, and underwriting capacity is inadequate to meet demand.
What's more, the current hard insurance market will probably be even longer than the 5-year post-Andrew cycle. Michael Paisan, insurance analyst for Williams Capital Group, explains why: "Despite the sideline capital that has entered in this market in the aftermath of 9/11, it is not nearly enough to supplant the lost capital. Moreover, the capital that is entering the market now has to be disciplined capital (unlike that in 1992) because the low interest rate environment is not as conducive to cash flow underwriting as it was back then. Hence, the capital inflow should not curtail the hardening pricing cycle as it has done in the past."
After Andrew, about $4 billion of new capital was raised in about 12 months. About $20 billion of new capital entered the reinsurance industry within four months following 9/11. It sounds like a lot, but the supply of reinsurance underwriting capacity is still lagging demand.