Commercial Catastrophes

In the summer of 2004, five major storms hit Florida, causing losses that rival those seen after Sept. 11. Sound terrible?  Depends on how you look at it. Dan Ferris explains how to double your money with disaster…

“Forgive me if this sounds crass, but it’s true. Disasters like Hurricane Andrew and 9/11 are exactly the type of big, ugly misfortune that creates Extreme Value opportunities.”

Those are my words.

They appeared in the letter I wrote to subscribers in January of this year. I went on to describe how an opportunity to safely double your money over the next few years was created by some of the worst catastrophes in history…

Hurricane Andrew struck in 1992, causing record insurance losses of approximately $22 billion. That record stood until 9/11, estimates for which top $50 billion.

Then came the summer of 2004.

Hurricanes Charley, Frances, Ivan, Jeanne and Tropical Storm Bonnie all hit Florida in a 48-day span, the most tropical activity one state has suffered in 130 years. More than one in every five Florida homes has sustained some type of storm damage. The number of insurance claims this season is expected to hit 2 million, far surpassing the 700,000 claims filed after Andrew 12 years ago.

Bob Hartwig, chief economist for the Insurance Information Institute, estimates the four hurricanes that made all the headlines cost $21.7 billion in insured losses. To put all these numbers in perspective, take note of this tidbit from the August issue of Reinsurance magazine: “The annual mean insured damage bill and its standard deviation for hurricanes striking the continental United States between 1900-2002 is $2.9 [billion] and $6.7 [billion].” Hurricanes from 1992 and 2004 are 7 1/2 times the mean, and more than three times the standard deviation.

Reinsurance: Losses from the Hurricane Season

But $21.7 billion is not the whole story. The storms that have made headlines aren’t half of what took place this year. So far this year, 12 named storms have formed, including eight hurricanes. Six of the storms had winds greater than 110 mph. It’s no wonder, then, that Jay Fishman, CEO of St. Paul Travelers Companies Inc., says losses from this year’s hurricane season now rival those seen after 9/11. Some estimates of the damage caused by hurricanes in 2004 are as high as $45 billion, more than twice the estimates for the four headliners. That’s about 15% of one year’s premiums for the entire U.S. insurance market ($300 billion), wiped out in just 48 days.

Catastrophes are hard on insurance companies. In the aftermath of Hurricane Andrew, 12 insurance companies went out of business. The events of 9/11 put 38 companies out of business, including Kemper, then the seventh-largest insurer in the United States, and Gerling Reinsurance, the seventh-largest reinsurer in the world.

So far, the 2004 hurricane season hasn’t put anyone out of business, but it’s an easy bet that it will. Bear in mind that the amount of new capital that entered insurance markets after 9/11 wasn’t nearly enough. Michael Paisan, insurance analyst with Williams Capital Group, said last year, “Despite the sideline capital that has entered in this market in the aftermath of 9/11, it is not nearly enough to supplant the lost capital. Moreover, the capital that is entering the market now has to be disciplined capital (unlike that in 1992) because the low interest rate environment is not as conducive to cash flow underwriting as it was back then. Hence the capital inflow should not curtail the hardening pricing cycle as it has done in the past.”

(A hardening price cycle, or hard market cycle, is easy to understand. It’s just like when you get into a car accident: Your insurance goes up. Same thing here. Soft cycles are the opposite, when prices fall; it’s harder to make money selling insurance. If you’re a really good driver and never get into an accident or get so much as a parking ticket…you get the picture.)

Reinsurance: 10% Wipeout

About $20 billion of new capital entered the reinsurance business in the four months following 9/11. That’s less than half of the $50 billion estimates for that day’s tragic losses. And now, the 2004 hurricane season has come, with losses currently estimated in the mid-$20 billion range. In other words, the 2004 hurricane season has already obliterated all the new capital that rushed into insurance markets in the wake of 9/11. International Finance Corporation reports, “All told, 10% of the world’s insurance capacity – the amount of money available for insurance – was wiped out by the [9/11] terrorist attacks.”

Think about that last sentence for just a minute, and you’ll begin to realize that there’s some serious money to be made here. If 10% of the world’s oil supply suddenly went up in smoke, you’d want to be long oil in a big way. Not only that, everybody and his brother would be telling everybody else to buy oil. It would hit all the headlines, magazine covers and cable TV financial shows. People would make money. They’d feel the financial acumen coursing through their veins, making them sexier and smarter every minute, even though the whole world already knows what they just found out, indicating that the opportunity was probably about to fall apart on them.

But for some reason, that hasn’t happened in the insurance stocks. Ten percent of the world’s insurance capacity goes up in smoke, and I can’t name one investor, friend, acquaintance or shoeshine boy who’s yelling it from the top of his lungs. No CNBC. No magazine covers. No headlines. Nothing. It’s like there’s some type of political blackout on reporting the opportunity in the insurance business.

But that opportunity is very much like the one in oil. Capital has avoided this sector for years in favor of technology and financial markets. For most of the last 25 years, the insurance industry could make money buying stocks and bonds. Interest rates were 15% back in the early 1980s. Stocks produced double-digit returns from 1982-2000. Making money in the financial markets was easy. Who needed to know anything about insurance? Nobody. You could just buy Microsoft or Cisco or Amazon and then wait a couple of years. With everybody making easy money in the stock market, capital – of which there’s a finite supply at any given moment – was diverted from other industries, like oil, shipping and insurance.

Lots of people are interested in oil now, even though oil prices are already at 450% of their level at the bottom in late 1998. Reinsurance prices shot up only 20-100% in the wake of 9/11. Surely, there must be more upside in reinsurance than in oil. When people talk about reinsurance the way they’re talking about oil today, then I’ll know it’s time to sell. It feels right to be interested in the reinsurance business at a time when the fundamentals are improving and nobody else seems to care about it.

Reinsurance: Laziness Born of easy Money

“S&P estimates that the reinsurance industries’ average combined ratio fell to about 97% in 2003 and, barring major catastrophes, expects it to improve further in 2004. This clearly shows that investment income does not subsidize poor underwriting anymore,” said Clemens Muth, head of economic and insurance research for Munich Re, the largest reinsurance company in the world.

As a result of the laziness born of easy money, the property/casualty and reinsurance industries have done a miserable job of pricing risk over the last two decades or so. They’re like a bunch of fat boxers who’ve run out of money, and now they think they’re going to get back in the ring after sitting around eating bonbons for 20 years. Since 1975, the entire property/casualty industry took in more premiums than it paid out in losses in only two years. Pathetic.

Of course, the property/casualty companies are the ones who buy catastrophe reinsurance, the type of coverage an insurance company needs to handle events like hurricanes and 9/11. The Reinsurance Association of America reports that reinsurance industry losses were never less than 101.5% of premiums for the period from 1981-2002. The average ratio was 111.6%. Put another way, the best the reinsurance industry could do was to pay out 1.5% more in losses than it made in premiums. On average, the reinsurance industry as a whole paid out 11.6% more than it received in premiums.


Dan Ferris
For The Daily Reckoning
October 14, 2004

House prices on the West Coast have “flattened,” according the L.A. Times. We have no word from the other coast…but the house builders’ stocks are going down.

Here in London, prices seem to be going down, too.

Three busts are coming:

A bust in China – the country has been adding capacity for demand that does not really exist.

A bust in the United States – consumers have been buying things (often from China) that they don’t need with money they haven’t got.

A worldwide bust in property – goosed by the Fed’s low rates, it’s gone up so far, in many areas, that the typical householder can no longer afford the typical house.

How and when these busts happen, we don’t know. But the bust in American consumer spending threatens to be more painful than we expected. For as it turns out, consumers have not only been buying things they don’t need with money they don’t have, but things they do need too.

“Today people are incurring a more dangerous kind of debt,” says Tamara Draut, director of economic opportunity programs at Demos, a public policy organization in New York that’s conducting a nationwide study of Americans and debt.

“People are living paycheck to paycheck, and after they’ve paid the bills, everything else – like groceries or back-to-school clothes – goes on the credit card,” Draut adds. “Credit cards are picking up the slack in the household budget.”

This new kind of credit card debt is called “survival debt.” The savings rate fell to only 1.3% last year. Without savings, every setback must be met with debt. Little by little, people get in the habit of putting everyday expenses on a credit card – groceries, rent, etc. – and then waiting for a paycheck to keep up with the payments. “The bills mount up,” says Draut, “it’s not just the rate going forward, it’s everything you purchased on that card.”

Survival debt is unlike other credit card debt in that it is less easily curbed, say the debt counselors. You don’t have to take a trip to the Bahamas, they point out, but you still have to pay the rent. You can’t even put it off. Last year, consumers charged $50.6 billion worth of household expenses on Visa alone – a 27% increase over 2002.

We are suspicious. In the article we read on “survival debt,” the authors mentioned cable TV as though it were an ordinary living expense, rather than a frivolous, and in our opinion obnoxious, luxury.

We recall a recent study of people “struggling” to get by on $36,000 for a family of four. And yet we recall also our story of Morning Naughten, whose family lived on only $30,000 – and saved $500 each month! Did the poor woman’s family go hungry? Did they shiver in the cold? Or did they merely have to make do without the purchasing power of credit cards or the cultural enrichment of cable television?

Americans may have less money to spend in the future. But so what? Their problem has not been too little purchasing power, but too much. Would it be a bad thing if they spent less and saved more? Would it be a bad thing if house prices fell; perhaps they could afford to buy one, rather than simply making payments on an interest-only mortgage? Would it be a bad thing if stocks dropped to the point where they gave their owners a decent dividend yield?

We remain optimistic, as always. The coming busts will crush the American consumer, we believe. He will be broken and bent – but perhaps into a better shape.

More news, from Eric Fry in Manhattan:


“In an era of $50 oil, and increasingly unreliable supply chains, the oil sands of Alberta assume a far more prominent position – strategically and geologically – among the world’s largest deposits. For one thing, $50 oil renders the relatively high-cost production of syncrude immensely profitable…”


Bill Bonner, back in London:

*** “For the first time in the post-World War II era, the United States faces a future in which every major category of federal spending is projected to grow at least as fast as, or faster than, the economy for many years to come. That means not just pension and health care benefits for retiring ‘baby boomers,’ or increasing interest payments as deficits and interest rates rise, but also appropriated or ‘discretionary’ spending for national defense, for foreign aid and for domestic homeland security programs,” writes Pete Peterson.

*** “When the Asian financial crisis hit in 1997-98, the U.S. Federal Reserve tolerated a liquidity boom that spawned the Internet bubble. When the Internet bubble burst, the Fed tolerated another wave of liquidity, which has led to the global property bubble,” says Andy Xie of Morgan Stanley. And the debt bubble in Anglo-Saxon countries. And the capital investment bubble in China.

“China’s boom is itself partly the product of the Fed’s super-lax monetary policy,” concluded the economist. “With its currency pegged to the dollar, China has been forced to import America’s easy monetary conditions. Its [China’s] higher interest rates have attracted large inflows of capital that have inflated domestic liquidity, encouraging excessive investment and bank lending in some sectors that could lead to a bust.”

*** Busts, busts, busts…and more busts. Get ready for them, dear reader. Enjoy them.

*** Money. Money. Money. It seems as though people think of little else. We write about it every day, but we don’t understand why people make such a fuss about it.

Here in Europe, we the humble scribes at The Daily Reckoning like to keep things simple and inexpensive. Like Morning Naughten, we have discovered that you can live reasonably well on relatively little money.

We don’t need much. Just the other day, the gardener at our country place asked if we would like to install an automatic watering system in the new ornamental gardens we are building. “No,” we replied, “just do it the old-fashioned way…you can water them with a hose.”

Keep it simple.

And then, our secretary asked if we would like to have some new-fangled cable TV system at our apartment in London.

“No,” we replied again. “We don’t have that at our apartment in Paris. We’ll make do without it here, either.”

Keep it cheap.

*** A Daily Reckoning reader comments:

“Today, we are witnessing two unfortunate realities. First, an administration that has lied so much they actually believe their own lies and preach them at every opportunity as if it the new gospel. When faced with overwhelming evidence that the cause of the war was unjust, all they do is stage more press conferences with even more determination and emotion that they have done the right thing to protect America. I believe it was some famous Nazi who said, ‘If you make the lie big enough, it becomes the new truth.’?

“The second seems to be the incredible gullibility of the public to believe these lies despite all the evidence. It would be unpatriotic to question them.

“So the band plays on, and people dance, eat and drink. All the while the water rises deck by deck through the ship. Peak oil arrives, and people look upon it as some strange thing they have never seen, much like the dinosaurs must have looked upon the light that streaked through the sky on that fateful day some 65 million years ago. Report after report is starting to reveal just how much financial trouble there is with Social Security, medical and all these government programs. The water rises, but just one more dance – the music is so good.

“I live in a world of mass delusion, which believes it will not end. Trust me, I live in California! This is why there is no outrage, because there is nothing perceived as wrong. In fact, I feel that the public in general is completely unaware of just how bad the future could be in the not-so-distant years.

“This morning, I was in the backyard and saw a passenger plane (maybe a 737) fly over, and I could not help but think that in 30 more years, they will be no more, and I will only be 65 at that time. When you really look at Peak oil alongside the demographics of aging in this nation, I think it is the closest thing to Armageddon I have ever seen. Yet, not a damn word is said in these debates about this iceberg.

“How can people not notice the slant? Do people not hear the water? Is the music so wonderful that it drowns out all else? Lies have become truth, and the truth is called lies. Regardless, I am 35, and I plan to live a long and good life, within my means, protecting my wealth through all that will come in the next 30 years.

“So every month I travel to the local coin store and contribute to the only savings I can see lasting in the face of such problems…sometimes silver, sometimes gold, because when I look towards my retirement some 30 or more years from now, paper has no real value except for fires, wrapping stuff and wiping your privates.

“History is incredible at times, and historically, we must be completely blind.”

The Daily Reckoning