Most people think insurance companies must pay the price tag for damages caused by the recent terrorist attacks. But, in fact, the buck stops with companies that insure insurance companies: reinsurers.
Most insurance policies -- particularly high-risk ones -- are reinsured. That's certainly the case for insurance firms covering many of the companies impacted by the attacks. For example, the World Trade Center housed numerous high-risk companies, including international import/export, shipping, oil and financial companies, as well as foreign political entities, with a great deal of money at stake.
But reinsurance companies can foot the bill, industry experts say. The Pentagon announced on Friday that it will cost $520 million to repair the damage to its building, and insurers estimate a $70 billion to $100 billion price tag for the destroyed World Trade Center and to the businesses as well as the people who worked there.
Globally, reinsurers have $280 billion in capital on hand, according to Donald Watson, director of Standard & Poor's' insurance group. If the reinsurers need more money, they can raise it through equity and bond markets, Watson adds.
"Given the returns that insurance stocks had in 1992 following Hurricane Andrew and in 1994 following the Northridge Earthquake in California, it should be relatively easy for the reinsurers to raise cash because the perception among investors is that the insurance industry does very well following a catastrophe," Watson says.
Indeed, after such an event, the need for reinsurance companies grows. An increasing number of businesses and individuals seek greater insurance coverage and, in turn, those insurers will buy reinsurance policies. At the same time, the menace of terrorism increases the chance that clients will need to cash in their insurance policies and reinsurers will become reluctant to take on such risk. As a result, they will increase their premiums and rates.
"Insurers may want to write exclusions for terrorist attacks in their contracts," adds David Greenfield, a partner with KPMG's New York insurance practice.
Such changes should comfort investors in reinsurance companies. If another catastrophic terrorist incident doesn't occur, the additional funds raised through higher rates should boost reinsurers' profits.Indeed, all these factors combined have made the industry a good investment opportunity.
During the three weeks since Sept. 11, reinsurance "stocks have had a big run up, with some of them rising 40% or more," says Edwin Walczak, portfolio manager of the $125 million
Vontobel U.S. Value Fund. With 60% of its assets in insurance, the fund has increased only 5%, according to Morningstar.
And there are more increases to come, says Walczak, who adds that he will stay heavily invested in insurance companies.
Howard Alter, president of Alter Asset Management, agrees. Noting that
, which owns a number of reinsurers, is a good stock to own, Alter told
"Martini Chat" program last week, "Insurance companies with strong balance sheets will come through the terrorist disaster with a Darwinian advantage: fewer players, higher demand for product and double-digit price increases."
While demand will help reinsurance companies in the long run, the short-term payout will weaken their cash positions. "We expect a downgrade in the bond ratings of many of the reinsurers," Watson says. "Already, we've put 23 groups on credit watch because we believe their ratings could fall. We don't expect insolvencies, but we do expect them to fall two notches."
To be sure, not all insurers will survive this catastrophe. "A loss of this magnitude will test the industry in a manner not seen before," according to a report on the cost of the terrorist attack issued by Tillinghast-Towers Perrin, an actuarial and management consulting firm that also runs a reinsurance subsidiary of its own.
"Reinsurance and other pooling mechanisms are designed to spread catastrophic losses broadly across the industry," the report said. "Given the magnitude of the loss, some of these mechanisms will not work as expected. Some
insurance companies will find that their reinsurance protection is inadequate."