Earthquake Insurance

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 Earthquakes may not be linked to each other, but they are linked to the financial markets, as anyone who has invested in insurers over the long term knows.

A natural human response to a catastrophe is to buy insurance in case it recurs. And rising demand in the aftermath of an earthquake or hurricane allows the industry to push up prices.

Often, price rises are helped along by a sharp easing of competitive pressure as some insurers, hit by gigantic claims, withdraw from the market since they no longer have enough capital to write new business.

However, with insurance stocks still mostly hovering below their pre-March 11 levels, investors appear to be betting against a transformation in the industry’s pricing power this time round, according to Andy Broadfield, an analyst at Barclays Capital in London.

“The market shoots first and asks questions later — the share price reaction tends to be a spike down, and then, depending on whether the outlook has changed, a spike back up,” he said.

“At the moment, the market’s telling us there isn’t a big enough impact to change prices. It’s pricing in the losses, and perhaps a very, very small improvement in the outlook.”

The European insurance share index, home to the world’s top reinsurers, fell nearly 9 percent in the five days after the March 11 quake, and is still 2.4 percent below its March 10 closing level, underperforming the wider market, which is about 1 percent above its March 10 close.

In the United States, the Standard & Poor’s insurance index has also struggled, climbing just 0.8 percent since before the quake, trailing a 2.9 percent gain for the wider S&P 500.

That is in contrast to the aftermath of Hurricane Katrina in 2005, when most insurance stocks rose strongly in the expectation that the industry would be able to deliver bumper shareholder returns on the back of a steady increase in prices.

But what investors did not foresee was that the prospect of strong returns would also encourage cut-throat competition.

That, coupled with a relative dearth of major insured losses, has resulted in flat or falling prices across most categories of global insurance and reinsurance for the last four years.

Swiss Re, the world’s second-biggest reinsurer, reckons the industry has already absorbed some $43 billion in losses from earthquakes in Chile and New Zealand and floods in Australia last year, and some analysts and brokers say the additional impact of the Japanese quake could yet firm up prices.

Most in the industry agree that whatever happens to the broader market, the price of pure earthquake coverage will probably rise strongly as insurers reconsider their appetite for risk in the light of the Japanese disaster.

“What it might do is cause some insurers to reassess the pricing they have in place for earthquake cover,” said Luke Savage, chief financial officer of Lloyd’s of London.

“In places like Chile and New Zealand, earthquake cover was with hindsight fairly reasonably priced and I don’t think insurers can continue to offer cover in those areas at such reasonable prices going forwards,” he said.

If prices rise, consumers and companies would get pinched. Some legislators are looking for ways to soften the blow.

Senate Bill 637, introduced by California’s two senators a week after the Japan quake, would create a system of federal guarantees for up to $5 billion in bonds issued post-catastrophe by public/private partnerships that meet a strict set of financial criteria.

While the CEA is the only organization in the country that meets the definition, there may be others soon.

Pomeroy said he has spoken to five national insurers about whether they would take part in such a partnership in other states, and all have said yes.

In the meantime, he estimated quake-insured California homeowners would save $100 million a year if the bill passed. ”What that guarantee would do for us is give us the certainty that private debt markets would lend to us after an event, which would let us cut back on some of our reinsurance,” he said. Pomeroy reckoned premiums for CEA policies would fall by at least a third if SB 637 became law.

And yet, big insurers are adamant that in the normal course of events, the industry is better equipped than any government to provide affordable earthquake coverage in high-risk areas, given its superior expertise in risk management.

“I don’t think the government could provide quake insurance any cheaper than the insurance industry,” said Andreas Schraft, head of catastrophe perils at Swiss Re. “An insurer with a global spread in its portfolio would have much better diversification and would have a lower cost of capital than a government that only covers earthquake risk in a small area.”

However things shake out on the cost front, everyone in the industry agrees that the Japanese disaster has put earthquakes plainly on the radar for consumers and insurers.

“We clearly went through a phase when every catastrophe headline was a hurricane and we’ve now gone through a phase where every catastrophe headline was an earthquake,” RMS’s Muir-Wood said.

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