Policy Documents

Japan Earthquake Developments and Impact on the Industry

Michael G. Paisan and Mariza F. Costa –
March 14, 2011

What is most remarkable to us is the need for some observers to provide an estimate for total insured losses – even as the event was still unfolding and under the scenario where at best, one might be able to ascertain a logical guess with a 5% confidence factor. The purpose for throwing around “estimated” numbers for losses of the Japanese earthquake and tsunami while it was still unfolding is not only beyond comprehension but seems irresponsible at the very least. Perhaps the motivation was to put fear into the markets, but as we saw from some of the market reaction, eventually the market reacts in a fairly rational way, as many of the property/casualty reinsurance stocks began to react later in the day in a more rational way that would indicate the initial fear of potential losses was unfounded. The irrational rush to quantify notwithstanding, we believe it is more important to understand the Japanese insurance market and get a feel of how this event could affect reinsurance pricing in that region and more broadly, because at the end of the day that is more useful in gauging how the reinsurer stocks could perform longer term from the confluence of catastrophic events worldwide in the last year. In short, we believe, regardless of what the ultimate insured losses are in Japan - $5 billion, $10 billion or $30 billion – it will certainly change pricing in the Asian and Australian region. Moreover, the confluence of all the many severe catastrophic events in the past year – accentuated by the recent Japan quake - should raise the overall stature of risk potential worldwide. Hence, we do believe that the aggregation of the Chile earthquake, two Australian floods, and Australian typhoon, two New Zealand earthquakes and the major earthquake in Japan will have at least a stabilizing effect on the overall catastrophe reinsurance marketplace – and the quarter is not even over yet.

Most reinsurers have described the overall global catastrophe reinsurance marketplace as the more stable of all the sectors of the property/casualty industry – with U.S. wind almost unanimously mentioned as the MOST stable in terms of pricing for property and cat reinsurance. That means, by definition, that the non-U.S. wind sector had been under at least a little more pressure from a pricing perspective. We believe that these aggregate cat events will add more stability to the non U.S. market, meaning the overall global reinsurance market will likely be better priced for the next year – perhaps a “head fake” harder market as we call it. It will not necessarily arise solely because of big losses in Japan, but rather because of the mounting awareness of overall risk exposures worldwide as a result of cat losses that have been unprecedented and unable to be modeled – “unmodelable”?. No one can say what the losses will ultimately be to the Japanese earthquake/tsunami at his time, but the rush to judgments seemingly moments after the catastrophic events really served no purpose whatsoever. What is more appropriate is to understand how the perception of risk might be affected going forward, and from that perspective, we believe the non “modelable” and unprecedented catastrophic events associated with Japan and the rest of the world this year will increase the overall perception of catastrophic risks from events that had been relatively dormant in the most recent past and, thus, the reinsurance market could be a beneficiary of that – especially at April 1 renewals.

The 8.9M earthquake that hit Japan last Friday will likely have an impact on the (re)insurance industry, particularly on companies that have been diversifying their CAT exposure outside of the peak zone of U.S. wind. However, the Japanese insurance is a little distinct in that much of the risk has been kept “in house” - through a government-sponsored catastrophe reinsurance program. The obvious main concern is the loss of life from this event, which could be very large. It will take a while for the total losses to the industry to be known; however, this event will likely have some kind of impact on (re)insurers that have a global platform, like many of the Bermuda companies we follow. The extent of that impact to earnings, pricing, and more importantly capital will not be known for some time, but it is probably safe to assume that first quarter earnings will be considerably hurt for many reinsurance companies with a heavy proportion of cat business.