The Japanese Earthquake and Insurance Companies

By: Money_Morning

David Zeiler writes: With estimates for insured losses from Japan's March 11 earthquake ranging from $12 billion to $35 billion, many investors have lost faith in reinsurance companies that have exposure to the stricken island nation.

But despite having to make some significant payouts, reinsurers ultimately may prosper from the disaster.

"Reinsurers typically benefit from a major disaster that's big enough to affect prices but not big enough to kill the industry," Karl Huber, a fund manager at Pioneer Investments in Munich, told Bloomberg Business Week. "That's the business of reinsurance."

There are two key reasons why Japan's loss will translate to a gain for insurance companies:

•The first is that earthquake insurance is already high in Japan, so few of the nation's citizens and businesses opt for coverage.

•And the second is that insurance companies will use this crisis as justification for further rate increases.
That's not what you would expect given the performance of many insurance stocks over the past week. Insurance company stocks suffered huge losses in the wake of the powerful 9.0 quake, which along with the tsunami it spawned, inflicted catastrophic damage across northeastern Japan.

Flagstone Reinsurance Holdings SA (NYSE: FSR) has plunged 25.7% since March 10, while Swiss Re ADR (PINK: SWCEY) is down nearly 7%. Among the U.S. insurers, Aflac Incorporated (NYSE: AFL) has slipped 10.5%, MetLife Inc. (NYSE: MET) is down more than 4.5%, Prudential Financial Inc. (NYSE: PRU) gave up 5%, and Berkshire Hathaway Inc. (NYSE: BRK.A, BRK.B) is down 2.5%.

However, many analysts say this industry-wide sell-off may be overdone, because the bill for insurance companies is unlikely to reach the lofty levels many are predicting. Indeed, there's likely to be considerable difference between the cost of Japan's reconstruction and the cost to insurers.

The Inside Scoop on Insurance
While the direct monetary costs from the earthquake and tsunami will range from $160 billion to $200 billion, insured losses will fall between $12 billion and $25 billion, according to catastrophe modeling firm Eqecat. Rival firm AJR Worldwide puts the figure between $15 billion and $35 billion.

The first reason for this disparity is that earthquake insurance is too costly for many in Japan to afford.

"Japan has a very different insurance market. It's likely to be a much smaller proportion of the total economic loss than if this happened in the U.S.," Don Windeler, a director in the natural catastrophe and portfolio solutions group at catastrophe modeling firm RMS, told MarketWatch. "There's much less purchase of quake insurance coverage on the commercial and industrial side in Japan. Quake is a special coverage that many companies opt not to take because it's so expensive."

At best, 30% of Japan's residents have earthquake coverage, and in some areas the rate is as low as 10%, Windeler said.

Beyond that, strict sublimits mean a business policyholder will only receive $10 million on a commercial building worth $100 million. Similarly, residential policies use pro-rata formulas that only pay them 50 cents for every dollar they claim; lower payout policies are cheaper and thus more popular.

Make no mistake: There will be losses, but they will hardly be enough to overwhelm insurance companies. Instead, they'll provide the impetus for further rate increases by draining insurance companies' balance sheets.

"The Japanese quake finally exhausts the natural catastrophe budget for 2011 of a majority of reinsurance companies," Fabrizio Croce, a Zurich-based analyst with Kepler Capital Markets, told Bloomberg Business Week. "All the ingredients for market hardening are now perfect."

"Hardening" of the market is insurance-industry speak for raising prices for coverage.

Remember, insured losses from Hurricane Katrina reached $62.2 billion - or just about half of the total actual losses of $125 billion. And following that disaster, reinsurance rates that had been in decline for two years rose to their highest level in a decade.

Likewise, Hurricane Ike in 2008 inflicted $18.5 billion in losses on insurers on its way to spurring an 8% jump in rates that also reversed a two-year decline.

Perhaps that's why insurance company stocks actually rose following Katrina. The world's largest reinsurer, Munich Re Group (PINK: MURGY), rose 25% in six months; Swiss Re increased 14%. And the biggest winner, Amlin Plc. UNSP/ADR (PINK: APLCY), zoomed 49%.

And that pattern could repeat itself yet again.

"While what is currently happening in Japan is a great human tragedy, it made me bullish on reinsurers again," Moritz Rehmann, who helps manage about $13.9 billion at DJE Kapital AG in Munich, told Bloomberg Business Week.

However, analysts are quick to point out that U.S. insurers with operations in Japan face greater uncertainty, due to their emphasis on supplemental health and life insurance. But that's not all. The explosions that rocked the Fukushima Daiichi nuclear plant add another degree of difficulty.

A nuclear meltdown could mean scores of additional human losses, as well as long-term health problems for many Japanese.

"We believe that death claims [from the earthquake and tsunami] will be very manageable for the major players there," Scott Robinson, a senior vice president at Moody's Investors Service told The Wall Street Journal. "The big wild card is what happens on the nuclear front."

Japan comprises a significant portion of the business of several U.S. insurers. Japan accounts for about 42% of Prudential's earnings, about 20% of MetLife's, and between 70% and 75% of Aflac's.

Source : http://moneymorning.com/2011/03/21/...

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