Friday, September 22, 2017

Reinsurance industry braces for Harvey impact

Harvey brought an end to the 11-year US hurricane drought when it made landfall last Friday, but will it also bring an end to the soft reinsurance market that has coincided with this period of benign losses?

One of the consequences of the low cost of reinsurance during the past few years is that insurance companies, unsurprisingly, have been more willing than normal to take advantage by transferring risks to the reinsurance market, meaning that a large proportion of the exposures in Texas are likely to be sitting in London and Bermuda.

Even so, the initial assessment is that losses should be relatively easy for the industry to absorb. Harvey was the first Category 3 or higher hurricane to make landfall in the US since Wilma in late 2005, but the damage it has inflicted has mostly been through flooding rather than wind — and that will make a big difference to the insured losses, as well as to the scale of the human tragedy.

To be sure, big US losses are certainly capable of affecting the industry worldwide. Hurricane Andrew, which made landfall in Florida in 1992, was the costliest natural disaster in US history with total insured losses of US$15.5 billion (in 1992 terms), resulting in the insolvency of 11 insurance companies and prompting the entire industry to transform its approach to hurricane risk management and modelling.

While the Houston area does not compare to Miami in terms of property exposure, the oil refineries of southern Texas represent a major commercial exposure that could represent a solvency event for reinsurers if they suffered significant wind damage. But that has not been the case.

The storm made landfall close to the small town of Rockport as a Category 4 hurricane, but moved slowly and lost energy relatively quickly with limited direct structural damage beyond this immediate area.

“As devastating as the wind damage was in Rockport and surrounding towns, flooding from Harvey’s torrential rains has had the greatest impact,” said Eric Uhlhorn, principal scientist at AIR Worldwide. “With a lack of large-scale atmospheric steering, Harvey’s motion was stalled, resulting in extremely heavy and continuous tropical rainfall in a concentrated area.”

Indeed, catastrophic and unprecedented amounts of rain were unleashed in south-eastern Texas — close to 60 trillion litres by some estimates, or more than 2 million Olympic-sized swimming pools.

It is too early for estimates of the losses from flooding, but AIR Worldwide estimates that industry insured losses resulting from the winds and storm surge in Texas will range from US$1.2 billion to US$2.3 billion, which should not pose a serious issue for reinsurers.

Flood damage is a different story, as news coverage of the disaster amply demonstrates, with monitoring stations in downtown Houston measuring flood levels two or three metres higher than previous records, according to AIR’s Uhlhorn.

However, the sad reality for many homeowners is that insurance coverage is the exception rather than the rule. According to the Insurance Council of Texas, only about 20% have flood insurance, almost all of which is through the Federal Emergency Management Agency.

This is not entirely surprising. The last major flooding in Houston, 16 years ago, was billed as a once-in-500-year event, so many homeowners figured they had better things to do with the US$550-a-year premiums.

As a result, the biggest claims from Harvey are expected to be from commercial and business interruption, especially from the refineries, with roughly half of Texas’s refining capacity offline due to flooding, restricted truck deliveries and the closure of most ports in Texas and Louisiana. The storm even closed down some onshore drilling operations in the Eagle Ford Shale area and a chemical plant outside Houston exploded on Thursday.

While such losses will undoubtedly hurt earnings at reinsurers holding the biggest chunk of exposures, it is unlikely to change the direction of pricing in the reinsurance industry more generally.

However, if Harvey signals the start of a more active hurricane period in the North Atlantic, it could be a different story.

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