Why Florence Is Dangerous for Insurers

Some hurricanes are worse than others—both for people in the way and the insurance industry that tries to understand storms and put a price on their risks.

Source: WSJ - Paul J Davies | Published on September 13, 2018

A stormy view off the end of a fishing pier into the Atlantic Ocean. Rough seas are from the remnants of Hurricane Irma.

Hurricane Florence is highly unusual both because of where it is heading and the storm surges and flooding it might bring. That could be painful for the industry and the alternative capital that has changed the dynamics of catastrophe insurance in the past decade.

The industry has seen a big increase of new capital since the financial crisis, mainly through flows of fast-moving, alternative capital into catastrophe bonds and similar products. In 2008, alternative capital represented $19 billion, or 6%, of total reinsurance capital; at the end of the first quarter this year that had grown to $95 billion, or 16%, of industry capital, according to Moody’s Investors Service.

Investors in alternative capital—as well as insurers and reinsurers—rely on well-tuned models to set their expectations for losses and price their risks. The problem with a storm like Florence is that because it is very unusual, it is harder to predict the losses it will cause.

Only two hurricanes as strong as Florence have hit the Carolinas: Hazel in 1954, which caused $15 billion worth of losses in today’s money and Hugo in 1989, which cost $20 billion, according to modeling firm RMS.

Investors don’t like unexpected losses: They represent uncertainty, which can’t be calculated, rather than risk, which can be priced. A major unexpected loss is likely to make investors think twice before rushing back into alternative capital, so the industry could take longer to recover and prices could rise more sharply. That is good for the insurers left behind—so long as their losses haven’t been too great—but makes insurance more costly for everyone else.

Florence is unusual not only because of where it is heading, but also because it is expected to slow down dramatically when it nears the coast, according to AIR Worldwide, a risk modeling firm. This slow speed and the peculiar shallow coastal shelf off the Carolinas are likely to help the storm suck up more water and gather power, producing a bigger storm surge, pushing more seawater inland and bringing much more rain over several days. That means higher winds for longer and more flooding.

Flood risk is much harder to model than other perils because the high resolution that models need, which requires detailed land survey data and extra computing power. Flooding was a big problem after Hurricane Harvey in Texas last year, but there was limited flood insurance cover in the state. Analysts at Jefferies think there is much more private flood insurance in North Carolina for homes and businesses. Also, since last year, the National Flood Insurance Program has bought more private reinsurance including the sale of its first catastrophe bonds, increasing the amount of money at risk from flood losses in general.

Last year, people in the industry spoke of a $100 billion loss as the kind of event that would finally push up pricing after years of declines or low growth. But the three Atlantic storms that hit the U.S. and Caribbean in 2017 caused losses greater than that and pricing still barely moved. Now industry participants think it would take $250 billion in losses, according to a survey this week from specialist research firm, Artemis. However, if the losses were more surprising, because they were beyond what models typically predicted, then a smaller loss of $150 billion could cause a contraction in the supply of capital to insurance markets and a rise in prices.

Storms like Florence are less well understood—and for investors that makes them more dangerous.