Hurricane Katrina has wreaked havoc in numerous ways: on peoples lives and homes that now have to be rebuilt, the US budget deficit which goes from bad to worse, and the insurance and reinsurance sector.
The bad news is that, while there is no consensus on the financial impact in the form of insurance claims, even the lower end of estimates of $40 billion would make it the biggest-ever single event for the insurance industry. Some estimates are in the region of $60 billion.
The good news is that insurers are generally are much better positioned to take the financial hit. The financial impact of the terrorist attacks of 9/11 was exacerbated by big asset losses as the prices of securities tumbled. Assuming there is no serious sell-off in fixed income or equities in the coming weeks seasoned market watchers believed there will be no need for most large insurers to undertake drastic fundraising.
Initial reactions suggest that the catastrophe bond market has held up well. Many hedge funds are now leading players in this market, but experts say the size, maturity and long-dated nature of the sector means most funds have been able to ride out the storm. Of more concern, they say, are industry loss warranty options, effectively a riskier version of a reinsurance contract, which many hedge funds are exposed to.
The main fears are for newer or marginal players such as some Bermudian firms and one or two Lloyds' syndicates. Monolines that have concentrated risk in property catastrophe businesses may also suffer some losses.
But there is an argument that any financial services firm that faces losses from one event that could amount to the equivalent of an entire year's profits would be wise to recapitalize when markets are accommodating.
Spreads have widened by as little as 10 basis points on most insurance credits since Katrina hit the US coast. Given investor demand for hybrid debt from the corporate and financial sectors, expect a round of such capital issues from the insurance sector over the next six months.