I'm always a little bit squeamish making a strict financial analysis of an event that causes many people enormous amounts of anguish. The financial cost that Hurricane Charley inflicted upon Florida pales in comparison with the heartbreak and loss that its victims will feel for years. I always try to keep such things in mind. This -- and those rare events like it -- is not really definable by the numbers, not on the granular level. As I write, there are 17 confirmed dead and several hundred people unaccounted for. That's a lot of families for whom the dollars are simply meaningless. I just want to keep such considerations at the center.
Last week I was joking as both Bonnie and Charley took dead aim at Florida that the folks in charge of naming hurricanes missed a perfect chance by not naming the "C" hurricane "Clyde" instead. That was before Charley suddenly wrapped up tight and climbed from being menacing storm (take it from someone from North Carolina, all hurricanes have the potential for mayhem) to one that was powerful enough to be a mortal risk for anyone in its path. Charley had the potential to be even worse -- just as Hurricane Andrew blitzed Florida and then went on to restrengthen and blast Louisiana, Charley went back out to sea and could have churned up the entire East Coast rather than drift northward offshore. Additionally, just like Andrew, Charley veered at the last moment and spared a big population center a direct hit; with Andrew passing just south of Miami in 1992, Charley bypassed Tampa. This is cold comfort to the denizens of Homestead and Punta Gorda, of course, but in each case the outcome could have been much, much worse. From a superlatives perspective, what is worse than "devastating"?
The aftermath of the storm isn't likely to be very happy for Floridians either. As it stands, two of the most devastating storms from a financial perspective have unleashed their fury on Florida, with Andrew's total damages coming in at $26.5 billion and the early estimates for Charley, according to reinsurer Munich Re, approaching $20 billion. Other risk assessors dropped their estimates over the weekend, some as low as $4 billion. Regardless, this will be one of the five most expensive hurricanes ever to hit the United States. And let's not mince words -- $4 billion is an enormous amount of money.
Apres Andrew, le deluge
Property insurance premiums in Florida skyrocketed after Andrew in 1992, but there's a reason for this: Florida real estate, especially coastal Florida real estate, is extraordinarily risky. Insurance companies are in the business of insuring against risk. Activities that entail higher amounts of risk equal higher risk premiums, equal higher payments. It is substantially more expensive for an astronaut or an Alaskan fishing boat worker to get life insurance than it is for an accountant, since the likelihood of a debilitating or fatal accounting accident is somewhat lower than one involving spacecraft or trawling. So it goes to figure that houses built on unstable land or in places where the likelihood of damage is higher are going to have to pay higher premiums. A house on the Outer Banks of North Carolina (a sandbar -- a moving sandbar) is more expensive to insure than houses just inland, in, say, Kinston, because the chance that a claim will have to be made on this property over time approaches 100%.
(A total side rant: In some places -- such as on sandbars, fault lines, and storm paths -- where insurance companies refuse to cover, the state steps in to provide "last resort" coverage. In other words, where insurance companies have determined that the risks people are taking are too high, someone else gets to pay: You do. Grrrrrr. Next time you're in Malibu, ask one of the folks with a beachfront home whether you can use his deck, since you're helping pay for it.)
Let's look at some silver linings here. From a financial perspective, the folks who are currently in the process of making claims for property loss from Charley need to thank their lucky stars for Andrew. Yes, you read that right. In 1992 many insurance companies were financially and structurally completely unprepared for the claims that poured in after Andrew: Most companies had simply not built in sufficient premiums to compensate for the risk of such a powerful storm. The identical thing happened with insurance companies in the aftermath of Sept. 11: They had insured buildings in downtowns throughout America without even considering the likelihood that they might be the targets of terrorist attacks.
In this regard, Andrew was a disaster. Eleven insurance companies went bankrupt, as their claims obligations far outstripped their abilities to pay. Several more quit insuring Florida real estate since they determined that they could not charge premiums sufficient enough to offset what must be considered high-frequency and high-cost risks. Many people who had duly paid insurance companies received no coverage as a result -- their insurers were insolvent. In the wake of Andrew, those insurers that did choose to remain in Florida jacked up their premiums by 100% to 200% in the coastal areas. While some accused the companies of profiteering, the answer was somewhat simpler: Andrew taught the surviving companies that the combination of rapid growth in population and real estate prices in Florida meant that hurricanes that hit the state were much greater financial disasters than in times past.
After Andrew, Allstate (NYSE:ALL) ratcheted back its coverage in Florida, as did State Farm. Prudential Financial (NYSE:PRU) withdrew entirely from the state. However, other companies, including Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) reinsurance divisions and Munich Re, Aspen Insurance (NYSE:AHL), and PartnerRe (NYSE:PRE) filled the void. They increased their premiums for Florida-based clients in order to give themselves adequate financial benefit to take on the risk of the next big storm. For Florida, the next big storm wasn't a myth -- it was a certainty. See GenRe and the Cost of Float for more explanation.
As such, even though several insurance companies have noted that the damage Charley cause would impact their financial results, this is what was supposed to happen. Unless companies have made the unpardonable sin of discounting the possibility or the cost of another megacatastrophe hitting the state, there should not be the same dislocation that happened under Andrew when insurers were unable to pay. After Andrew, the insurers who elected to remain in Florida raised their rates to compensate for the potential of more big storms coming. Helloooooo Charley.
This time it's different
Inasmuch as this is the case, Floridians shouldn't really expect their premiums to skyrocket in Charley's wake as they did after Andrew. The insurance companies -- if their underwriting has remained disciplined -- built in the risk of such an occurrence into existing premiums. It is, of course, possible that a megacatastrophe every 12 years is too frequent for some companies, and they may readjust. But Charley, and its eventual cost, shouldn't be a surprise like Andrew was.
You might be asking how companies could possibly cover the billions of dollars in claims, though. This is the realm of the re-insurers, insurance companies that provide insurance to other insurance companies. Insurance companies lay off a component of their risk by paying re-insurers to insure them in case of certain types of claims. If a house burns in a fire, or is robbed, the insurance company may be on the hook, but if a "megacatastrophe" takes place, the primary insurer has protection in the form of its own insurance policies. Expect the number of insurance companies and re-insurers reporting their exposure to Charley to be relatively high over the next few weeks.
This, by the way, is why any discussion of capping insurance premiums is economic ignorance at its worst. Insurance companies on the whole lose money from their underwriting of risk. Capping the premiums they charge ignores the cost of their coverage. New Jersey learned this the hard way when GEICO elected to cease offering auto coverage in the state rather than submit to state-mandated pricing. Insurance premiums are economically meaningful information -- the industry is too cutthroat for there to be much fat in pricing over the long term. New Jersey's premiums are high simply because the risk of owning a car in New Jersey is higher than almost anyplace else in America. (Coincidentally, GEICO announced today that it would begin offering automobile coverage in New Jersey, after a two-decade absence.)
So don't expect Charley to be the massively disjointing event that Andrew was a decade ago. Florida insurance laws have changed (in some ways for the worse), and the companies that chose to continue to write coverage in the state following the last big blow have done so with eyes wide open to the next big one. The premiums Florida residents have paid in the last 12 years are little more than the manifestation of the very costs that the insurers now have to absorb.
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Bill Mann owns shares of Berkshire Hathaway. He has experienced the following hurricanes: David, Frederic, Gloria, Fran, Floyd, Isabel, and Hugo. None fatal, none very fun, either.
