Speculation on the impact Katrina will have on insurance prices has begun, some reactionary and some thoughtful. RiskProf and Unintended Consequences both have expert commentary on this issue (see here, here). Although initial estimates of insured losses are all over the board at this early stage, from about $9 billion to $30 billion, the insured loss figure is going to be very large. Where will insurance pricing go? My two cents are that it is too early to tell where pricing is going, but also that insurance pricing won’t necessarily follow gasoline prices.
There is the potential for price increases, some significant, on a micro basis as both insurance and reinsurance underwriters reassess exposure for certain types of risk, for example beachfront property in Louisiana. One insurer has already decided to reduce their Florida homeowners exposure in the wake of Katrina. This micro analysis may or may not cause rate changes for specific types of risk, lines of business or locations, depending on the result of each underwriter’s reassessment.
In addition, there will certainly be pricing increases as inflationary types of impacts, such as the surge in gasoline prices, work through the system and increase insurance costs. However, this will take time and should be modest at best.
The critical question is the industry reaction, and on a macro basis it is too early to tell how pricing will change. A single large loss, by itself, is not necessarily a driver of pricing across the industry. The key factor in industry-wide pricing changes will be the cat’s impact on profitability and industry surplus. Surplus is the primary measure of industry capacity, and when surplus is constrained prices rise. In theory, if the loss is well spread and does not severely impact net income, and therefore surplus, capacity will not be constrained and there will be minimal change in industry pricing. On the other hand, if Katrina is followed by a couple of other, reasonably large cats and industry surplus is severely impacted we can expect significant rate changes across the board.
The industry has weathered major cats in the past, and even multiple cats, without a severe impact on pricing. And because of management and reinsurer pressures, property underwriters have worked hard to control aggregation, which in theory should control the net impact to any one insurer. We will see how well this effort has worked. My guess is that it has worked very well for some underwriters, and not so well for others.
One wildcard is the political reactions that may follow. At Unintended Consequences, Doug makes a great point in warning of the unintended consequences of quick political reaction to perceived insurance problems.
Update: One underwriter has a less positive perspective on the impact of Katrina. His SWAG for insured loss is north of $25 billion, and is based on speculation that there will be questions, which will be litigated, over whether the peril is wind or flood. He adds to this the length of time business interruption might apply and potential liability claims, unusual as a result of a cat, under GL, environmental and professional policies. He also speculates that the spread of risk may not be even, and some insurers will not make it.
In addition, Insurance Journal notes that Fitch Rating has listed some reason why insured losses may grow beyond current estimates (see here).