How Recent Hurricanes And Earthquakes Can Actually Benefit Reinsurance Investors

In a context of geopolitical instability, devastating natural disasters and record-high market valuations, finding investments that can protect investors from market sell-offs isn't easy. However, having a diversified portfolio is fundamental: Prioritizing stability and predictability over stock market-beating returns can be the difference between a safe retirement and a life of financial struggle.

Agecroft Partners’ Don Steinbrugge recently suggested cautious investors should consider some strategies with low correlations to the market like CTAs, direct lending or reinsurance.

Below is a closer look at reinsurance and why recent natural disasters like hurricanes Harvey, Irma and Maria, and the earthquakes in Mexico may drive reinsurance premiums up, benefitting reinsurance investors.

How Does Reinsurance Work?

Similar to what is seen in the mortgage market, where issuers can sell their loans to Wall Street and keep a transaction fee, insurance companies like Allstate Corp ALL, Chubb Ltd CB, American International Group Inc AIG, Metlife Inc MET or Prudential Public Limited Company (ADR) PUK pack their insurance policies and sell them to the market.

Buyers, usually reinsurance funds or companies like Everest Re Group Ltd RE, Reinsurance Group of America Inc RGA and RenaissanceRe Holdings Ltd. RNR, collect the premiums and assume the related liabilities, typically building a diversified holdings portfolio that includes policies from diverse perils and geographical areas.

It's important to note that reinsurance companies' stock prices will be impacted by a sell-off in the stock market, while a reinsurance fund's performance has a very low correlation to the stock and bond markets.

“The returns of reinsurance funds are completely independent of the capital markets, and are instead based on claims versus premium collected,” Steinbrugge told Benzinga, adding that over long periods of time many reinsurance funds should be able to generate high-single- or double-digit returns.

In most years, reinsurance funds generate positive returns. However, there are some years when claims are very high and thus, returns, very low or negative. And, this might be the case for 2017, as the world was hit by all kinds of natural disasters.

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A Bad Year

Forward-looking returns from reinsurance change over time and are impacted by both supply and demand for insurance. “Now, in periods where you have a lot of major events, reinsurance experiences pricing pressures, which means that the returns new investors coming in should expect from reinsurance should be higher as prices rise,” Steinbrugge explained.

Over the past few months, the world has experienced several major hurricanes such as Harvey, Irma and Maria. Verisk Analytics, Inc. VRSK’s AIR Worldwide has estimated losses from Hurricane Maria alone could add up to $40 billion to $85 billion for the insurance industry.

“When you add that to the other hurricanes and recent earthquakes we’ve had in Mexico, the total loss in the quarter ranges from $83 billion (on the low end of estimates) to $165 billion,” the expert said.

While the initial losses from these types of events are normally absorbed by traditional insurance companies, all those above a certain threshold are often assumed by reinsurance companies. “That’s a lot of money coming out of the reinsurance industry, and all that money needs to be replaced — and must be replaced between now and the end of the year. As that money is being replaced, it’s going to put upward pressure on the pricing for reinsurance.”

“Price increases will be moderated by new capital coming into the industry but also enhanced by investors withdrawing capital from underperforming funds,” Steinbrugge wrote in a white paper on the topic. So, ahead of the January reinsurance renewal season, Steinbrugge suggests investors take a closer look at this opportunity, arguing that occurrences like this year’s are rare and far apart.

Where To Invest

When there aren’t many claims, most reinsurance firms look alike. However, this won't be the case this year.

“What the past quarter is going to do is really stress-test reinsurance firms and demonstrate which ones had good risk control and underwriting standards, and which ones didn’t,” Steinbrugge said.

For risk-averse investors, catastrophe bonds (or CAT bonds) might be the best way to participate in the industry, he said. “These securities are traded on exchanges and are pretty liquid, so they are the most conservative way to participate in reinsurance,” he concluded, explaining that, while risk is mitigated in CAT bonds, so are yields. Conversely, reinsurance funds offer much higher returns, but are not as liquid, requiring investors to lock up their money for a certain period of time.

Image Credit: Javier Hasse