Trying to forecast exactly how Japan’s nuclear plant problems will play out is tough. As John Stepek pointed out in yesterday’s money morning: How the disaster in Japan will drive up energy prices, most of the ‘experts’ seem to have little more idea of what will happen than the rest of us.
So perhaps unsurprisingly, stock markets have been spooked worldwide. Before yesterday’s big rally, even the FTSE 100 had plunged almost 6% within a week.
This fear could well be rational. After all, Japan could yet be facing even bigger horrors than the quake has already caused.
Yet if the worst doesn’t happen, one sector that’s been hit harder than most could start to look very interesting for investors…
The financial cost of the Japanese disaster
Whatever transpires at the Fukushima power plant, it looks as though the damage done by Japan’s earthquake and tsunami will end up being the largest-ever earthquake loss for the insurance industry.
The latest estimates from ‘catastrophe-modelling’ company Eqecat are for insured losses – ie the costs that insurance companies will have to pick up – of between $12bn and $25bn. That compares with the $15bn expense of California’s 1995 earthquake, and last month’s in Christchurch, New Zealand, where insured costs could top $10bn.
Of course, the exact financial cost of the disaster won’t be known for months. The figures at the upper end of Eqecat’s range are someway lower than Sunday’s forecast by rival assessor AIR Worldwide. This suggested that insured property losses would be between $15bn and $35bn excluding tsunami damage.
Further, as Eqecat has pointed out, some $2bn to $4bn of the repair costs will be borne by the government’s Japan Earthquake Reinsurance Pool. That will cut the claims made against private insurers.
But even so, the bottom line for insurers still looks ugly, even before we know exactly what’s going to happen with the nuclear plant.
What’s more, the Japanese quake is just the latest in a string of disasters that have hit over the last 15 months or so. 2010 was already the second-worst year since 1980 for natural catastrophes. On top, for 2011, the insurance industry has already been counting the cost of claims from the likes of Australia’s severe storms and flooding in January.
A bad couple of years for the insurance industry
So many insurers are set to report losses in this year’s first quarter. Indeed, they may end up losing money for the whole of 2011. And several reinsurers, who provide extra slices of catastrophe exposure cover and are used by mainstream insurers to spread and diversify risk, could take a right pounding.
No wonder the sector has been amongst the worst hit. “The immediate reaction to footage of toppled buildings or floating houses”, says the FT’s Lex, “is to sell reinsurance stocks”.
Shares in the world’s largest reinsurers, Swiss Re (VX: RUKN) and Munich Re (GY: MUV2), who even before last week’s quake had already largely gone through their annual natural disaster provisions, had fallen over 15% in the last month before rallying a bit yesterday.
So does this all mean you should now steer well clear of insurance stocks?
Actually, no it doesn’t. Despite their recent troubles, insurers’ finances are generally in reasonable nick. As credit ratings agency Standard & Poor’s said this week, “much of the industry is dealing with this disaster from a position of capital strength”.
Of course, if a full-scale nuclear disaster develops, all bets could be off. That goes for equity markets too. But with that proviso, falling insurance stock prices could now be a buying opportunity.
Global insurance rates are likely to rise
Here’s why. If you’ve ever been unlucky enough to need to submit a chunky insurance claim, you’ll know what happens next. The insurance company finds a way to get its own back. Your next premium is hiked, because you’re now seen as representing a bigger risk.
Global insurance rates have been broadly falling for some time. But that could be about to change. As Lex notes, catastrophes aren’t necessarily bad news for reinsurers. That’s because they help keep prices for catastrophe reinsurance up, which otherwise “for US companies was set to fall by between 5% and 10% this year”.
“Of course, nobody wants global insured losses to exceed $100bn as they did in 2005. But when capital is eroded” – ie when the insurance market has to cut the amount of cover it can provide – “reinsurance prices have to rise to compensate”. In other words, premiums will rise. And that’s likely to restore reinsurers’ profits once again.
In turn, that would be good news for the sector’s share prices. On average, in the wake of the 16 largest global catastrophes on record, reinsurance stocks outperformed America’s S&P 500 for up to a year, says Citigroup.
So what to buy? Those two major reinsurers I mentioned earlier are starting to look quite interesting – both are now on 5%-plus yields.
There’s another key point here too. Despite those widespread share prices falls, by no means all insurers have the same exposure to Japan. That means there’s now some great value to be found elsewhere in the sector. And I’ll be spotlighting the companies I believe look the best bets in next week’s issue of MoneyWeek magazine.
Category: Market updates