Earthquakes, tornadoes and floods have combined to deplete capital levels across the insurance industry, costing as much as $50 billion so far in 2011, by some estimates. In a bid to recover losses, insurers raised policy rates not just in disaster-hit regions like Japan and New Zealand, but across all major catastrophe zones, including hurricane-prone southern states in the U.S.
Higher insurance rates mean potentially higher profit margins. And increased margins are tempting hedge funds, private-equity firms and even institutional investors, who have begun specialist underwriting businesses ready to write policies for the U.S. hurricane season.
"There has been an observable change in investor interest in property catastrophe insurance and reinsurance," said David Flandro, global business intelligence head at insurance broker Guy Carpenter.
"So far this year, $2 billion of new capital has entered the sector," he said.
From June to November every year, hurricanes develop in the Atlantic, and pass through the Gulf of Mexico, providing those who insure homes in the region with a regular stream of repeat business.
Gambling on the behavior of the weather can be risky. For example, Hurricane Katrina, which devastated New Orleans in 2005, was strong, but not the strongest hurricane to blow through the area that year. It was, however, by far the most destructive and expensive, eclipsing the Sept. 11, 2001, terrorist attacks as the most costly insured event in U.S. history, costing $55 billion.
Last year, 12 hurricanes swept through the Atlantic basin, but few caused serious damage and most ran out of steam over the U.S. East Coast. This year, forecasters from the U.S. government's National Hurricane Center are predicting as many as 10—still well above the long-term average of four.
And while forecasters claim to predict hurricane numbers, they can't predict how many will cause damage.
Wary of the risks, the outside investors have teamed up with experienced underwriters from established insurance companies to create new finance vehicles known as "sidecars." The sidecar structure aims to provide a safe way for investors to enter the catastrophe-insurance market even if they have no experience in the area.
In a sidecar, premiums are written by experienced underwriters from established insurance brands, which means the risks are well-priced. In return for their expertise the underwriters usually receive a cut of the profit.
Sidecars tend to focus on insuring the risks of other insurers, a market known as reinsurance. Retrocessional insurance, which underwrites the risks of reinsurers in a third level of cover, is also popular with sidecars. These forms of insurance provide the industry with extra protection in case losses mount too high.
The first sidecars were set up following 9/11, but it was not until after Hurricane Katrina that their popularity truly grew, when an estimated $34 billion in new capital flowed into the insurance market, around 13% of which came through sidecars.
Over the past few months a flurry of sidecars have been set up to take advantage of current premium rates for catastrophe insurance. London insurer Lancashire Holdings Ltd., announced the launch of Accordion Reinsurance Ltd. in May, backed by up to $250 million. Bermuda reinsurer Validus Holdings Ltd. announced a $180 million sidecar on June 1. In April, Bermuda reinsurer Alterra Capital Holdings Ltd. announced the creation of a $100 million sidecar New Point IV together with private-equity firm Stone Point Capital.
Outside of sidecars, investors have also shown interest in the insurance market via traditional equity investments. In May CatCo Reinsurance Opportunities Fund Ltd., a small London reinsurer, raised $124.4 million through an equity fund raising to take advantage of a "significant increase in premium rates."
Fellow reinsurers Beazley PLC and Amlin PLC have also indicated their readiness to pounce on any sharp rise in catastrophe insurance. Beazley's underwriting committee chairman Neil Maidment said a hurricane in the Gulf of Mexico may give rates another shove upward.
"Further loss activity will likely accelerate the rate changes we are seeing in the second quarter, which may lead to an increase in investor interest," said Maidment.
Rates have already increased by as much as 10% in some cases, according to broker Guy Carpenter. In May, reinsurance giant Munich Re said it expected price increases but didn't say by how much. Also in May, London insurer Hiscox estimated such increases could be in the order of 10% when it reported to the London stock market.
But another increase in insurance rates could attract what some describe as "silly capital"—investors keen to cash in on rising rates, but lacking the experience to price the underlying risks properly. Too much of this sort of capital can damp rate increases, as newcomers attempt to undercut established insurers, which in turn stops the industry from quickly recapitalizing.