As if the physical damage caused by Hurricane Sandy wasn't enough, soon consumers and businesses alike will face additional pain from increased property insurance premiums. Though the superstorm was one for the ages, it's not the only reason we may see policy costs rise in the near future. And though the average consumer may not enjoy the new rates, a few choice companies certainly will, giving you great investment opportunities.

The hard and soft of the matter
Historically, insurance companies operate under two scenarios: "hard" and "soft" markets:

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Source: Insurance Information Institute (Robert Hartwig). 

Recently, insurers enjoyed a soft market, with available funds topping out around a near-record $568 billion at the end of June, even after the claims from Hurricane Irene and other weather incidents last year. Given the cyclical nature of the insurance market, insurers expected the market to harden to encourage price increases. Sandy was just the thing to spur on that market change.

One storm to rule them all...
It may not seem like a surprise that insurance companies would raise rates after a historic storm sweeps half the nation. But typically, one major event would not be reason enough for insurance companies to raise their policy rates. Legally, insurance companies like Allstate (NYSE:ALL) and Berkshire Hathaway's (NYSE:BRK-B) GEICO cannot recoup losses, like the $25 billion expected from Hurricane Sandy-related claims, by raising rates after each event.

So in order for the companies to shore up financially, they tighten up underwriting practices and raise rates to reflect the anticipated risk of future storms and catastrophes. Three storms (Sandy, Irene, and Lee) hitting the Northeastern U.S. in the past 14 months gives sufficient support to insurers to pull the rate-hike trigger.

Size matters
According to the National Association of Insurance Commissioners, Berkshire and Allstate hold a large portion of the property and casualty insurance market:

Insurance Company

Rank in NAIC Market Share Research

Total Written Premiums

% of Market

Berkshire Hathaway

7

$17.8 billion

3.6%

Allstate

4

$26.4 billion

5.3%

State Farm 

1

$52.6 billion

10.5%

Source: NAIC 2011 Market Research.

With such large base of policyholders, these companies will have an easier time spreading out rate increases. Though residents in states hit hardest by the recent storm will most likely see their rates increase first, residents in other states will have to share the cash flow burden -- though they probably won't see increases until policy-renewal time.

The pluses and minuses of specializing
While companies with large market share will be able to raise rates over a large swath of policyholders, some companies that specialize in niche markets may have a harder time hiking their prices. AIG (NYSE:AIG), for example, focuses its property and casualty underwriting on non-traditional properties, with a dedicated division for coastal condominium, motel, and hotel properties -- one of the hardest-hit segments during the recent storm. Since this is a smaller market, and AIG doesn't have the same overall share of written premiums, policy holders may feel a bigger sting from the company's rate hikes.

But other companies that specialize in higher-risk properties may end up benefiting from new "hard times." Markel (NYSE:MKL) specializes its P&C services in certain areas, including high-risk underwriting. For clients that are turned down by traditional insurance companies, Markel steps in with customized solutions. Since the insurance business is headed toward a harder market, with tighter restrictions from other insurance companies creating more "high-risk" clients, this non-traditional insurer may bring in new policyholders by the bushel.

The sad truth
One of the sad stories coming from many victims of Hurricane Sandy is that their lack of flood insurance has wiped out any hope of reconstruction. Only 14% of homeowners in the Northeast had a flood policy in place when Sandy hit, and unfortunately, most homeowner policies won't cover damage from flooding -- even if it's caused by a hurricane.

With this news coming to light, many homeowners and businesses are looking into flood policies -- setting up Marsh & McLennan (NYSE:MMC) for a new policy windfall. Many customers take advantage of the federally backed flood insurance policies from National Flood Insurance Program, which Marsh facilitates and also supplements with additional private coverage policies.

A Fool's takeaway
With fully stocked balance sheets, most insurance companies will weather Sandy (and its subsequent property damage claims) well enough. Premium rate hikes are never painless, but the larger companies by market share will get through with minimal damage.

Investors should take a look at the companies that will have added growth as a result of the storm, but Fools need to be cautious about those insurers' underwriting practices. Just because insurers specialize in high-risk and flood policies, doesn't mean they should gobble up an influx of new customers without the proper level of underwriting scrutiny -- they'll end up with something akin to an ice cream-induced stomachache.

Jessica Alling has no positions in the stocks mentioned above. The Motley Fool owns shares of American International Group and has the following options: long JAN 2014 $25.00 calls on American International Group. Motley Fool newsletter services recommend American International Group, Berkshire Hathaway, and Markel. Try any of our Foolish newsletter services free for 30 days.

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