Not with a Bang, but a Whimper

As we go to press with this issue, it is just past the one-year anniversary of Hurricane Katrina, a Category 3 hurricane with sustained winds of 200 km-h that unleashed the flood waters of Lake Pontchartrain in New Orleans and inflicted more than US$57 billion of damage in Florida, Louisiana, Mississippi and Alabama.

Of course, the devastating year of 2005 did not end there. Hurricanes Wilma and Rita followed shortly thereafter, causing an additional, estimated US$20 billion in damage. By the time the janitor turned out the lights on the 2005 storm season, there had been more named storms than letters in the alphabet (the first time that’s ever happened). Globally, Swiss Re estimated, total estimated insured damages in 2005 cost the industry roughly US$83 billion.

Canada was not immune. Record-breaking storm damage in the Toronto/GTA area, a fire at an oil facility in Alberta, and Montral floods all contributed to insured catastrophe damage losses of roughly CD$2 billion in 2005 – again, a record.

All told, the storms effectively cancelled out what had otherwise been a good financial year for North America’s insurance industry. Without the storms, A.M. Best reports, the combined ratios for the U.S. industry would have been a very profitable 92.9% in 2005 and 94.5% in 2004. As the Property and Casualty Insurance Compensation Corporation (PACICC) reported in the September 2006 issue of Canadian Underwriter, if the 2005 Canadian storms had happened during a hard market year, such as 2001, for example, about 10% of the Canadian industry’s equity would have been wiped out and up to six of the nation’s insurers might have been facing financially hardship or posting out-of-business signs. As it stands, the Canadian industry reported a respectable overall COR of 94.7% in 2005.

How did the North American insurance industry respond to last year’s damages? Basically, it fear-mongered itself into preparing for even worse. Certainly a wise strategy, and it will be interesting to see how it plays out by the end of fiscal year 2006.

Over the past year, we have heard many reports of a squeeze on insurers’ capacity. Ratings agencies changed their models for capital requirement, requiring insurers to raise more capital. Catastrophe models changed in order to account for weaknesses exposed in the original models that had underestimated Katrina damages. With both storm surge and demand surge now incorporated into the models, insurers and reinsurers are once again required to raise more capital.

All of this happened in an environment of fear and dread. Earlier this year, A.M. Best published a report that speculated as to what would happen to the industry in 2006 if a cataclysmic Category 5 “mega-hurricane” cut through Miami – or New York and New Jersey – and caused more than $US100 billion. In April 2006, respected weather prognosticator Tropical Storm Risk (TSR) called for an “above average” 2006 storm season. It predicted 15 named storms and about four “intense,” Category 3-5 hurricanes, two of which were predicted to reach U.S. landfall.

So here we are, three months into the 2006 storm season, and what’s happened? As of press time, Hurricane Ernesto had already turned into a mere rainstorm by the time it made U.S. landfall. Category 1 hurricane Florence is predicted to hit Newfoundland as a downgraded tropical storm. Researchers at Colorado University and TSR have both downgraded the number of major hurricanes they had initially predicted for this season. And that has summed up the 2006 storm season thus far: major threats have petered out into relative nothing.

Of course, catastrophes are by nature unpredictable. It could well be that by the time this issue reaches our audience, Vancouver or Montral will have experienced a major earthquake. Or maybe a major hurricane will have swept through the Atlantic. Or one could easily see Toronto suffering another blackout after twisters touch down in the GTA. It is the nature of the insurance business to take such possibilities into account.

Still, touch wood, what will happen if the industry’s fears for 2006 aren’t realized? Assume for a moment that this “quiet” trend continues for the balance of the year. What will the property and casualty industry’s balance sheets look like at the end of the year?

Based on the preparatory capital-raising we have all heard about, you would expect a relative non-year on the catastrophe front for 2006 might mean insurers and reinsurers will be hanging onto an awful lot of capital by the end of the year – capital that won’t be required to pay for predicted mega-storms. This expectation is amplified by the observation that early returns for 2006 are very similar to the early returns for 2005. The financial returns for 2006 should prove to be healthy for the industry. Time will tell, of course.

But if this trend carries out to the rest of the year, where will all of this capital go? Ratings agencies are already noticing softening markets in North America – particularly in the commercial lines. And so, rather than preparing for the storm seasons of 2007-08, it already looks like the U.S. insurance industry is facing a future of squandering gains made in 2006 – gains that were much-needed in light of what happened last year. Hopefully, this is a trend that will not be imported into Canada.