Higher Premiums Are Likely to Slow Economy
The insurance losses from the attacks on the World Trade Center and Pentagon, already estimated at $40 billion, could easily reach $70 billion to become the worst disaster in insurance industry history.
Yet the stocks of insurance companies have rebounded sharply since a few days after the Sept. 11 attacks and most now are selling near their highest prices of recent years.
Why? Anticipation of future gains is replacing horror at current losses. Investors see that insurance companies will be able to raise premiums dramatically in the months and years ahead. The world’s leading insurers, led by Lloyds of London--a collective name for 108 insurance-writing syndicates--said last week that commercial property premiums would rise by more than 80%.
U.S. investment analysts predict a doubling of premiums on the many forms of insurance carried by business, from property and equipment to life and health coverage for employees.
The insurance industry is a mirror and a weather vane. A look at the industry reflects how tough the business environment will be in the next few years and at the same time how well some insurance firms are likely to fare.
The insurance bill is going to hit business hard--premiums can typically amount to 10% of a company’s operating costs, experts say. Also, there could be less insurance available because insurers will set lower limits on the risks they will cover. (Individual homeowner and auto insurance rates may not be affected, analysts say, because the retail market works on a different dynamic.)
Federal Reserve Chairman Alan Greenspan last week included higher insurance premiums among the added costs that will slow the economy’s productivity gains in the years immediately ahead.
The higher premiums are intended to replenish reserves that will be drawn down by companies paying claims. But Wall Street investors clearly think the higher premiums will more than offset the losses, enabling insurance firms to increase profits. Also, as weaker firms pull back, stronger firms will gain business.
Industry leaders agree. Maurice “Hank” Greenberg, chairman of American International Group, one of the world’s largest insurers, told investment analysts recently that opportunities for his 82-year-old company have never been greater.
Michael O’Halleran, president of Aon Corp., a large insurance brokerage and consulting firm, says that even now “new money is coming into this industry, new companies are being formed from within existing firms.”
He’s referring to companies and joint ventures being formed to handle some of today’s most prominent risks. Twelve days after the terrorist attacks, AIG formed a venture of 14 firms worldwide to provide emergency insurance to airlines.
Marsh & McLennan Cos., the largest insurance brokering and consulting company with $10 billion in annual revenue, has set up a new company, Axis Inc., with $1 billion of capital to insure property, aviation, war risk and political risk.
The new ventures will not insure against terrorism, though. The Bush administration, with industry backing, is proposing that the U.S. government cap insurance firms’ liability on terrorism claims and form a special pool to handle terrorism risk, because companies won’t write insurance on it at this time.
There is precedent for government action. Just such an insurance pool covers nuclear power plants in the United States. And Britain set up a terrorism insurance pool in the 1970s against the risk of Irish Republican Army terrorism. The aim is to allow commerce to go forward, because it would stall without insurance.
Industrial customers who pay the premiums, not surprisingly, are skeptical of insurers’ appeals for help. “They’re always crying ‘poor me.’ Then they charge what the traffic will bear,” says Edward Abbott, chairman of Abacus Capital, a San Francisco real estate investment firm. He says insurance premiums can amount to 3% of a building’s revenue.
Higher premiums will increase office rents, Abbott says, but apartment building owners will find it hard to raise rents in a poor economy.
Many firms, facing higher premiums, will choose to self-insure at least part of their operations, accepting the entire risk of loss. In such cases, insurance consulting firms are still called in to manage the risk allocation. The next few years will see innovations in financial markets used to help offset the costs of risk management, Aon’s O’Halleran predicts.
Businesses will have to partially self-insure because insurers are cutting their risk limits, reports analyst Alice Cornish of Prudential Securities. Where the industry would insure an energy project up to $75 million before Sept. 11, for example, now a single company will insure the same project only to $25 million.
Such cutbacks could be temporary, however, because the industry doesn’t lack for resources. Berkshire Hathaway, the holding company run by master investors Warren Buffett and Charles Munger, gets 60% of its revenue from insurance through ownership of Geico, General Reinsurance and other firms. Berkshire Hathaway will pay more than $2 billion in claims because of the Sept. 11 attacks, but it has reserves many times that amount built up over many years.
The insurance business is simple, Buffett has written in his renowned annual report: “The premiums are received before the losses are paid, an interval that sometimes extends over many years. During that time, the insurer invests the money,” and makes gains in investment markets. Analysts commend Berkshire Hathaway these days because it has tens of billions in cash available not only to pay claims but also to seize opportunities.
Even the reinsurance companies--pools of capital on which insurance firms lay off some of their highest risks--are in good shape, says analyst Bill Yankus of Fox, Pitt, Kelton, a New York investment firm. Yankus cites such reinsurers as Ace Ltd., XL Capital and Partner Reinsurance, all based in Bermuda, and Everest Reinsurance, which is based in Barbados.
But the insurance industry, which took in $300 billion in premium income last year, was ready to increase premiums even before Sept. 11, in order to reverse a pattern of the last decade in which companies lost money paying out claims but more than made up such losses in investment markets.
In the last year, however, investment income went down as insurance losses mounted, says analyst Cornish of Prudential.
“So the industry was going to raise premiums more than 10% even if Sept. 11 had been only a sunny day in New York,” Cornish says. Tragically, it was not and in the aftermath, insurance and all the world’s industry will be paying the costs and adapting to changed conditions for years to come.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Hope After Horror
Stocks of many insurance companies have rebounded sharply after an initial fall following the Sept. 11 attacks on the World Trade Center and Pentagon. Two of the largest insurance companies, France’s Axa and Germany’s Allianz, have not rebounded, possibly because they lack strong following among U.S. analysts.
*--*
Stock price Stock price Percentage Company Sept. 10 Oct. 19 change Insurers Allianz* $23.79 $22.58 --5.0% AIG 74.26 81.60 +9.8 Axa* 23.63 20.15 --14.7 Berkshire Hathaway 68,000.00 74,300.00 +9.3 Chubb 66.47 73.30 +10.3 Insurance brokers Marsh & McLennan 87.00 98.15 +12.8 Aon 36.71 40.61 +10.6 Reinsurers Ace 33.00 36.50 +10.6 XL Capital 82.00 91.80 +12.0
*--*
*Trades in American depositary receipts
Source: Bloomberg News
*
James Flanigan can be reached at jim.flanigan@latimes.com
