While estimated losses still vary, most now concede that Katrina was a market-changing event with market-changing consequences, says Lindsey Rogerson

A final sum for the devastation wrought by Hurricane Katrina may still be months - even years - away, but already some of the world's biggest reinsurance groups have had to revise initial estimates upwards, and more importantly for the investment community, their earning forecasts downwards.

What is more, set in the context of escalating frequency of tropical storms - at the time of writing Rita was gathering pace (the 17th storm so far this year) - the prospect for ongoing losses to catastrophe reinsurers is a distinct possibility. Indeed Lewis Phillips an analyst at Benfield said this could prove to be the costliest year on record for reinsurers.

The power of ratings

Moody's, Standard & Poor's, Fitch and AM Best have all issued downgrades or put reinsurers on credit watch in the aftermath of Katrina. Such downgrades could prove crucial should any of these reinsurers seek to raise capital. Bond fund managers are often restricted in what bond issues they can get involved with according to the rating classification given to a company. Specifically, should any organisation's rating fall below "BBB" they will find themselves excluded from the selection of all but high yield bond managers.

On the plus side, both analysts and investment managers agreed that restructuring of the property & casualty businesses and tighter underwriting in recent years will help mitigate the longer term damage caused to reinsurance balance sheets.

Alec Foster, a fund manager at Hiscox Insurance Portfolio, said: "At the beginning of this decade, property & casualty companies, after ten years of awful pricing, living on investment returns and ingrained with bad habits, either put their houses in order, or disappeared. As a result, those remaining are better managed and considerably stronger than they have ever been. This loss will not blow them off course, although there may be some failures."

To be fair, much of the uncertainty surrounding the final insured loss figure, and reinsurers' individual exposures to it, has been as a result of poor access to the area of destruction. Quite rightly, the priority was to rescue stranded residents, not to get loss adjusters into the region - and so initial estimates have had to be revised. Recently Swiss Re doubled its estimate to $1.2bn, Munich Re has also revised its initial estimate of up to EUR650m, and Lloyd's has said it may be months before it knows whether its initial prediction of a $2.5bn loss is accurate.

The wind/flood debacle

Of more immediate significance to the asset managers is the impact on earnings. Swiss Re has said Katrina will dent earnings, as has Hannover Re, and recently PXRE became the first to admit that insured losses for the hurricane will mean a loss of between $85m and $165m for this financial year.

A key factor in the eventual size of the final insured losses for Katrina will be how the damage is categorised explains Foster, "Are losses a result of wind, flood, or flood caused by wind? The distinction between flood damage due to the breach of the levees and the storm damage surge caused by wind will be critical to the size of the insured loss. Because New Orleans was a well-identified flood risk, flood is rarely covered within standard homeowners and commercial lines policies."

Business interruption costs, so far estimated at $100m a day, and the amount of damage done to the 1,200 oil rigs in the Gulf of Mexico also impact on the final total. However for reinsurers with healthy reserves Foster believes Katrina will ultimately present opportunities. "Whatever the size of the ultimate insured loss, cat reinsurance rates in the US and elsewhere will rise," he says. "Rates in other less directly associated classes could also harden due to the increased reinsurance costs. As with most large losses, the consequential increase in customer demand and the upward adjustment in pricing creates opportunities."

Rates surge upwards

Chaucer Holdings was one of the first Lloyd's group to announce its intention to capitalise on perceived opportunities, when it announced it will be retaining its current underwriting capacity of £400m into 2006, reversing an earlier decision to cut it to £350m next year. This view of Katrina as a market changing event was leant further weight when Benfield released its half year results. CEO Grahame Chilton said that Katrina's loss currently estimated at between $40bn-$60bn will drive up both catastrophe rates and demand for cover.

Indeed Swiss Re's CEO John Coomber called for just such rate rises at last month's Monte Carlo meeting. He said, "We are witnessing increasing natural catastrophe events across the globe, affecting economies and societies with a higher frequency and severity. Price levels in the upcoming renewals must be adjusted to reflect these developments."

It is this anticipation that rates and business volumes are set to rise that helps to explain the rising share prices of some reinsurers post-Katrina. Recent hurricanes in Florida have forced up property rates by as much as 20% according to some analysts. Then there is Kiln and Fox-Pitt, Kelton, which are predicting premium increases possibly as high as 50% for those looking to insure oil rigs and refineries in and around the Gulf of Mexico.

Taking Munich Re as an example, no fewer than three analysts have moved the reinsurer to outperform (Landesbank Rheinland-Pfalz, Cheuvreux and Credit Suisse First Boston) or strong buy (Sal Oppenhiem) since Katrina struck. And viewed at the three-month mark Munich Re shares are up from their 1 July position, supporting analysts' views that companies that have strong reserves and have been exercising discipline in their underwriting will ultimately be able to capitalise from any market upturn.

Lindsey Rogerson is a freelance journalist.

Investment Montpelier Re loss estimates

On 12 September, Montpelier Re estimated the net impact of Hurricane Katrina and the New Orleans flood losses to be in the range of $450m - $675m, based on private industry insured loss estimates of $30bn - $40bn. It has since announced in an SEC filing that this original loss estimate may be exceeded. Assessing the developing market opportunities in the aftermath of the catastrophic event, Anthony Taylor, chairman, president and chief executive, said, "We are currently assessing those opportunities and related capital requirements and the board of directors will take appropriate actions as the situation evolves. We have always said that we would flex our capital according to market conditions." On 15 September the company confirmed that it had entered into an agreement to sell 25,850,926 common shares to Lehman Brothers and confirmed the sale the following day. Commenting on the decision by Standard & Poor's to reaffirm Montpelier's "A-" ratings and remove from credit watch, credit analyst Steven Ader said, "The ratings were removed from CreditWatch due to the capital benefit derived from Montpelier's successful raising of $600m of equity capital. The raised funds have materially reduced the potential that Katrina losses in combination with additional catastrophes could result in an imbalance between Montpelier's capital base and its prospective business opportunities."
Investment Underwriting opportunity

The view that Katrina will ultimately prove an underwriting opportunity for reinsurers has further strengthened in the aftermath of Hurricane Rita. Citigroup European reinsurance analyst, James Quin, said he believes companies are well-positioned, and expects earnings estimates to be boosted as well, on the back of expectation that rates may rise by as much as 15%. He singled out Munich Re as the European group most likely to capitalise on any opportunities. While across the Atlantic his colleague, Joshua Shanker, is also anticipating a hardening market for reinsurers, singling out Arch Capital and PartnerRe (which he upgraded to "buy") as the most likely to benefit from the developing market environment.