Who Pays for Hurricane Sandy Damages? More Than Just Your Insurance Company

By Sterling Wong  NOV 02, 2012 2:45 PM

Reinsurers, a.k.a., insurance for insurance companies, will foot a large portion of the Sandy bill. So will taxpayers.


MINYANVILLE ORIGINAL In terms of financial damage wreaked by Hurricane Sandy, there’s good and bad news. The good news is that despite its severity, Sandy losses will not come close to those from 2005’s Hurricane Katrina. The bad? Sandy will still likely become one of the five most expensive hurricanes in history.
According to disaster modeling company Eqecat, insured losses from Sandy will total some $20 billion when all is said and done, double the damage from last year’s Hurricane Irene.
Which are the property and catastrophe (P&C) insurance companies most exposed to Sandy?

Steven G. Bazil, founding partner of Bazil McNulty, a law firm that represents insurance companies around the world, tells Minyanville that the list probably includes the usual suspects such as Ace (NYSE:ACE), Allstate (NYSE:ALL), AIG (NYSE:AIG), Chubb (NYSE:CB), Cincinnati Financial (NASDAQ:CINF), Progressive (NYSE:PGR), Hartford (NYSE:HIG), Arch (NYSE:ACGL), and Travelers (NYSE:TRV).
But when victims of Sandy receive their insurance payouts, they might be surprised to learn that the money does not actually come from the primary insurers from whom they bought their P&C policies. Insurance companies also purchase insurance, as it turns out. They buy them from reinsurance companies to protect them from catastrophic events that triggers a large number of payouts.
“Reinsurance works in a similar way to how you and I would buy a homeowner’s policy or auto policy from Geico, where we can decide the deductible amount and the types of coverage limits we want to have,” explains Roberts DiUbaldo, a New York-based attorney from Edwards Wildman, whose practice is focused on US and international insurance and reinsurance companies. “It’s the same principle except that reinsurance is negotiated between the insurance companies and reinsurance company," he tells Minyanville.
So major reinsurers like Munich Re (BIT:MUV2), Swiss Re (PINK:SSREY), Berkshire Hathaway (NYSE:BRK.A) (which owns Geico), and Everest RE (NYSE:RE) could sign contracts where they reimburse 100% of what insurance companies pay out to P&C claimants, or they could have treaties where if an insured part has a $5 million loss, the reinsurer covers $2 million and the insurer pays $3 million because it did not purchase coverage for that amount. Such an agreement is termed an excess of loss treaty. Many reinsurance contracts are shared among several reinsurers in the same way lenders syndicate large credit facilities among several banks. So reinsurers cover insurance companies. But even reinsurers need backup. To hedge against extreme risks, reinsurers and insurers issue catastrophe bonds to investors, who receive handsome yields and get their principal back if nothing occurs over the life of the bond. However, in the event of catastrophes ("cats" in insurance-speak), their money is surrendered to reinsurers and insurers who use the money to pay claim-holders.
The Role of Catastrophe Bonds
Does that mean that the average investor is ultimately footing the bill for Sandy? Not quite. Though there are about 14 cat bonds worth some $3.6 billion that are exposed to Sandy, "the current estimates of insured losses are not enough to trigger full payouts from any exposed bonds," Antonio Guevara-Mazariego of cat bond broker Tullett Prebon, told Reuters. Even Katrina only partially triggered one cat bond that covered the Gulf region.
Reinsurance companies apparently have more than enough capital to manage losses incurred by Sandy, thanks to strong earnings through the first three quarters, said ratings agency Standard & Poor’s in a report, so they wouldn’t need the financial assistance of cat bonds anyway.
“In our view, based on current industry loss estimates, the effect on ratings for the P&C (re)insurers and affected catastrophe bonds should be minimal,” S&P, who did point out that Sandy losses will probably affect reinsurers’ fourth-quarter earnings, surmised. The agency, however, cautioned that “these loss estimates could, and probably will, change and that uncertainty about the business interruption and contingent business interruption claim amounts is very high.”
Business Interruption Losses Might Pile Higher Than Damages
Alex Henlin, another attorney from Edwards Wildman with expertise in reinsurance, agrees that the more significant claims from Sandy might come from the business interruption front. While a property insurance policy typically only covers the physical damage to the business, business owners usually will also purchase business interruption insurance, which protects the loss of income, calculated as the profits that would have been earned, that a business suffers after a disaster. “Though physical damage claims will also be sizeable, the fact that Sandy hit such a business-dense area and has now disrupted normal operations for several days, with several more still likely to come, will increase the magnitude of the claims,” Henlin tells Minyanville.
“The critical question will be how property insurance carriers that wrote business in the affected areas reinsured their books,” he continues. “Particularly in the case of certain smaller insurers who have reinsured under excess of loss treaties, the percentage of losses passed on to reinsurance companies could be as high as 90%.”
Taxpayers on the Books as Well
While reinsurers will cover a large part of insured losses stemming from Sandy, taxpayers will actually end up sharing some of the financial losses, too, though this burden does not come up in Eqecat’s loss estimates. Homeowner insurance policies do not cover flood damage, which was, of course, significant in the tri-state area. Instead, private insurance companies offer flood damage policies that are underwritten by the Federal Emergency Management Agency's (FEMA’s) National Flood Insurance Program (NFIP), which is ostensibly funded by taxpayer dollars.
The NFIP has some $4 billion in cash and borrowing authority, but it will probably not end up dispensing much of it because only up to 25% of at-risk properties in the Northeast have flood protection, insurance experts told the Mississippi Sun Herald.
“Most surprising though, is that residents who have a federally-backed mortgage and live in a flood plain, who are required to have insurance against flood, very often don't have the required insurance. Other people might also think they will receive governmental disaster relief, and this may also be a reason why some do not purchase insurance,” explained Erwann Michel-Kerjan, managing director of the Wharton Risk Management and Decision Processes Center at the University of Pennsylvania, to the Sun Herald.

Twitter: @sterlingwong
No positions in stocks mentioned.

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