The great escape

The recent UK flooding has hit the insurance industry hard but, despite warnings that profits could be impacted negatively, reinsurers are likely to escape the brunt of the storm.

Torrential rain in central and northern England, which began on 25 June, has flooded tens of thousands of properties, killed at least five people and forced 30,000 people to evacuate their homes.

“Britain is enduring its worst flooding since the 1930’s and the estimated cost to the insurance industry is set to be the highest this year,” said Dr Justin Butler, managing director of Ambiental Technical Solutions. “Individuals and government simply weren’t prepared for the scale of the damage caused by the flooding.”

With flooding continuing into July, the estimated cost is rising. Early this month, Risk Management Solutions (RMS) predicted that the widespread flooding will cost the insurance industry £500m. This was followed by an announcement by the Association of British Insurers that it would be more in the region of £1bn and, more recently, Fitch Ratings have said the total could well exceed £3bn. With reports of fresh flooding in Oxford, along with fears that new parts of the country will be effected, the final bill is likely to increase further.

And according to Equity Red Star, increased catastrophe claims could see household insurance premiums rise by between 5 and 10% at the end of 2007. More worryingly, Aon has warned that insurers could withdraw flood cover altogehter in many parts of the UK unless the government builds better flood defences.

RMS’s announcement that this summer’s floods will not be as costly as the March 1947 floods provides little reprieve.

With insurance and reinsurance inextricably linked, how will the flooding impact reinsurers? On 17 July IPC Holdings reported that their second quarter 2007 earnings will be negatively affected by the flooding in both the UK and Australia. The announcement pushed the reinsurer’s shares down more than 7% and pressurised the stock of rivals, including Aspen Insurance.

“IPC Holding’s announcement raises the obvious question of what other companies may be exposed to with the UK and Australian floods,” said Thomas Cholnoky, analyst at Goldman Sachs.

But it seems that whilst insurers have been caught in the eye of the storm, reinsures look set to be financially sheltered from the worst of the flooding. One reason for this is the high retentions of primary insurers.

“I don’t think there will be a significant loss for reinsurers because of the retentions being borne by primary insurers,” said Jean-Michel Lewis, director of reinsurance at Heath Lambert. “While it might hit the lower end of the reinsurance programme, I think it will be a minor hit.”

This view is supported by recent earnings figures from Bermudan reinsurers Everest Re Group and Partner Re, who reported net increases of 28% and 35% for the second quarter respectively.

The “168-hour rule” provides further cushioning for reinsurers. This rule prevents insurers from making joint reinsurance claims if floods occur more than 168 hours apart. Thus, insurers are not able to make a joint claim for floods in the Yorkshire and southern regions, meaning individual events are unlikely to trigger claims.

So, despite initial fears of profits drifting away with the flood waters, and re-ignited debate about whether a national reinsurance flood mutual is needed, reinsurers seem set to emerge from the worst floods since 1947 relatively unscathed.

But with scientists warning of an increase in the severity and frequency of catastrophes, reinsures must play their part in a collective consensus to reduce the damage of future floods.

“The huge cost of the recent floods, both financial and human, has highlighted the need for insurers and reinsurers, governments and businesses to better understand the potential impact and damage caused by catastrophic flood events,” said Butler.