Jubak's Journal
Recent articles:
• 5 baby blue chips you should know, 9/20/2005
• Has Congress sparked a banking crunch?, 9/16/2005
• Oil backlash? These 5 drillers will still find profits, 9/14/2005
More...
| | Jubak's Journal
Katrina is no disaster for insurance stocks
Although the industry as a whole will pay out billions in claims, the strongest insurers will end up in a better position. Here are five stocks to watch.
By Jim Jubak
Estimates for insured damage from Katrina in New Orleans and along the Gulf Coast have soared to a range of $40 billion to $60 billion. And they could go higher.
All of that is good news for insurance stocks. Or at least for the stocks of the insurers with the best balance sheets.
Now I know that's illogical, counterintuitive and just plain puzzling. But that's the way insurance stocks have behaved after other big disasters, and it's actually logical that the stocks of the "best-in-class" insurers should climb even as they're writing huge checks to cover insured losses.
The reason that some insurance stocks go up even as the industry pays out billions of dollars in claims comes down to supply and demand.
When the insurance industry is flush with cash, as it has been recently, insurers compete with each other to write new policies. That sends the price of insurance down and takes a bite out of insurance-company margins. At some point, some companies forget that the key goal in the insurance business is to sell policies at a price that will let the insurance company make a profit even if it has to pay out on a good many of its policies. These companies are so anxious to write new business that they sell policies at prices that virtually guarantee they'll take a loss. They hope to make up for such losses by making investment profits on the money they collect as premiums before they eventually have to pay claims on the policies. The most disciplined and most experienced insurance companies protect their future profits by passing up the revenue they'd book today if they matched these prices.
A disaster for the weak
Comes the disaster -- and it always comes, insurance companies know -- and suddenly the companies that rushed to write new policies are faced with the biggest claims. Since they were cutting prices to sell more insurance when the industry was flush with cash, these companies don't have the deepest claims reserves in the industry. Only in unusual cases are the claims so large that the insurance company can't pay in consequence. More often the result is that the insurance company has to dip so deeply into capital that it has to cut back on its underwriting of new policies while it goes to the capital markets to raise new cash. The capital markets charge more for that cash than before the disaster struck -- because money in general may be tighter and because after paying out millions in dollars on disaster claims an insurance company is a riskier borrower than before.
More from MSN Money
So, after a disaster, the industry as a whole has less capital, few insurance companies are eager to sell new policies, and the price of insurance goes up as the industry tries to make up for its losses.
It's in this post-disaster period of less supply and higher prices that the insurance companies who kept their discipline reap their rewards. They built up the strongest balance sheets in the industry during the good times, and they now have the capital to underwrite new policies at higher rates. And because their balance sheets are so strong, the capital markets charge them less than they charge competitors for new money, and customers looking for insurers strong enough to pay off in case of a disaster prefer to do business with these industry strong hands.
And that's why the doubling in forecasted insured losses is good for "best-in-class" insurance companies and their stocks. When Katrina was "just" a $20 billion to $30 billion disaster, it looked like insurance companies had enough capital to pay out on claims without sending rates higher. The industry had about $400 billion in capital at the end of 2004, according to Friedman, Billings, Ramsey, a huge increase from the $163 billion in capital in 1992, when the industry faced $15 billion in insured losses from Hurricane Andrew. At a projected $25 billion in insured losses, Katrina represented just 6.3% of industry capital, far less than the 9.5% represented by Andrew. That percentage was probably too low to raise industry pricing much post-Katrina.
| |
|
|
|
|
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.
|
