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Sandy Losses Manageable for Insurance Industry

A profitable year and the potential for a stronger pricing environment has left the insurance industry in a position to absorb losses, says Morningstar's Drew Woodbury.

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Drew Woodbury; he is an insurance Analyst here at Morningstar. We're going to see what impact the devastation of Hurricane Sandy will have on insurance companies.

Drew, thanks for talking with me.

Drew Woodbury: Thanks for having me.

Glaser: So, let's start with some estimates of the damage that this storm caused. I know we've heard a lot of numbers thrown around. How much damage do we think it caused, and how much of that will the insurance companies have to cover?

Woodbury: So, the estimates are still very early. The storm just recently hit. But what I've seen right now is for total losses approximately in the range of $10 billion to $20 billion, but that could change. The subways are still flooded, a lot of people are without power, so that loss estimate is from kind of early in the process. And so that could definitely change to the upward.

Of the insured amount that is about $5 billion to $10 billion. So about half of [the damage] right now [is covered]. The difference between those two is that flood insurance is not covered under standard insurance policies. So, that's run by a federal government program; so flooding is excluded from insurance policies.

Glaser: We look at that number $5 billion to $10 billion, you said it could possibly go even higher. Do the insurance companies have the capacity to pay out these claims without kind of endangering themselves? What's their capacity right now?

Woodbury: The good thing is that this year has been really benign for storms. So, with hurricanes, there were essentially none that made landfall in United States. Early in the year there were not many notable storms; there was the derecho, which wasn't too bad. So, they've had really robust profits for the year and really have strong balance sheets at this time. So, they are in very good position to pay claims.

Glaser: If they are able to payout these claims looking forward, what about pricing? Are they going to be able to maybe recapture it through higher pricing, or is the competitive situation such that that won't be possible?

Woodbury: For a little bit of background for the past few years the insurance market has been in what's called the soft period, where prices have been declining. More recently in recent quarters, there has been some mid- to upper-single-digit price increases, which has been kind of a positive sign, and people are hoping that maybe that would lead to a more improved market. It's yet to be seen, but it's possible that these losses could motivate a change in the industrial behavior, cause people to look back at their book, and see what their pricing levels are in aggregate. It could also cause some capacity withdraw from the industry which supply and demand dictates would lead to higher prices. It's difficult to determine at this time, but could be offset a little bit by some price increases.

Glaser: Looking at the fair value estimates, are you making any changes?

Woodbury: No. Insurance companies are in the business of accepting large storm risks. This is kind of part of their business that quarters are volatile, so it's not fair for the skittish investors. But this is definitely what they are there to do, accept these risks and pay people who have lost their homes or whatever else.

Glaser: Looking at some individual names, do you think there are certain companies that are better-positioned or worse-positioned after the storm, or is it too early to say?

Woodbury: It's a little bit difficult to say. Even those that are going to be hit hardest, they maybe have the most volatile earnings. But they usually make it back, and they are the ones that actually had the best profits in the early half of the year. If it leads to a higher pricing market, we think some of the specialty insurers, such as WR Berkley, ticker WRB, or HCC Insurance Holdings, ticker HCC, have some extra capacity to write additional policies if the pricing market hardens. They are in the best position to capitalize on a hardening market, but not necessarily directly related to storm.

Glaser: Well, Drew, thanks so much for your thoughts today.

Woodbury: Thank you for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.