15 July 2005

External Risk: The Economics of Catastrophe...

The risk of an active 2005 hurricane season is raising the stakes for business in the energy and financial services sectors at an accelerated pace.

Hurricanes are threatening our oil production in the Gulf of Mexico and crude is trading at $US61.

Oil prices rose for a second day, after the US Government said more than half of Gulf of Mexico output remained shut down following Hurricane Dennis. A new storm is approaching the region, raising concern about supply shortages.

Production in the Gulf was 43 per cent of normal at noon New York time yesterday, compared with 4 per cent the previous day, figures from the US Minerals Management Service showed. Tropical storm Emily formed in the Caribbean and next week might reach the gulf, the source of a third of US oil output.

"Now there are worries about this tropical storm, Emily, they're getting all these big storms really quite early in the season," said David Thurtell, commodity strategist at Commonwealth Bank.

"If you get these continued disruptions, then second-half production is going to disappoint."

Insurers and other firms in the financial services sector are at risk if regulators don't allow them to increase premiums. Business could be impacted by those higher premiums or the risk of losing coverage all together.

Last year was difficult for insurers as four major hurricanes in the Southeast triggered about $23 billion in payouts.

In Florida, where insurers paid the most damages from last year's hurricanes, companies have so far had little success in getting regulators to allow higher premium prices.

But another year of hurricanes on par with 2004 could give insurers more leverage in applying for higher premiums, said Mike Paisan, an insurance analyst at Legg Mason in New York.

"If Florida regulators do not allow higher prices, major insurers could threaten to withdraw. Having fewer insurance companies there would definitely raise prices," Paisan said.

The risk of loss from external events such as these are hard to predict, yet easier to prepare for each year. Predictive models are getting better and the largest and most savvy insurers are using them to their benefit. AIR's Catastrophe Models are a prime example.

Lloyd's Loss Modeling Department has licensed AIR Worldwide's catastrophe risk management system to assess the risk from global catastrophes and for the simulation of Realistic Disaster Scenarios (RDS).

RDSs test the ability of the market and individual syndicates to withstand large catastrophes such as a major hurricane hitting the Miami area or a severe earthquake striking downtown Los Angeles. By bringing the AIR models in house, Lloyd's risk management team will have a better understanding of the potential impact of such scenarios. All Lloyd's managing agents are required to complete RDS exercises annually.

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