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Financial Planning > Tax Planning > Tax Loss Harvesting

The Long and Winding Road

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In the space of one week in August, the East Coast was hit with an earthquake felt from North Carolina to Boston and as far west as Chicago, and Hurricane Irene roared along its length, devastating habitations and businesses from the Caribbean to Vermont and beyond with wind and water. Fortunately, the earthquake did not do substantial damage; however, it provided plenty of food for thought in an area unaccustomed to feeling the ground shake underfoot.

Natural disasters are growing more frequent and severe, their collective losses taking an ever greater toll on insurers and reinsurers—$23.5 billion from tornadoes and other severe weather in the United States in the first half of 2011 alone, according to Munich Re. Globally, the total for the first six months was $265 billion.

Predictions of more frequent and more severe climate conditions seem to imply increasingly greater losses for insurers. We spoke with Steven Weisbart, senior vice president and chief economist at the Insurance Information Institute (III), to see what the future may hold.

The insurance industry is sound, says Weisbart, thanks to the “new normal”—property/casualty insurance losses amounting to more than $25 billion for catastrophes in five out of the last 11 years, including this one. “The industry as a whole is in very sound financial shape in spite of the extraordinary year as far as [catastrophic] damage is concerned,” he says. “The industry was very well-prepared.” The reason, he adds, is those last 11 years. “The worst year was 2005,” he points out, “but 2001, 2004, 2008, were all $26–27 billion. It’s hard to know what this [year] will end up being, but I would guess $25–30 billion.”

While losses from Hurricane Irene are extensive, insurance companies may not bear the brunt of it; for one thing, uninsured losses make up a huge portion of the damage and disruption, and for another, floods are not covered under most policies. Instead, the federal government’s National Flood Insurance Program (NFIP) will end up footing the bill—to its additional deficit.

Insured losses, Weisbart estimates at press time, could be in the $3 billion–$6 billion range, with the uninsured losses coming in substantially higher. “Typically they are about twice the insured loss,” he says. “In this case,” he predicts, “they will be closer to three times the insured loss, because more of the damages would be of the uninsured type. Looking at the low end, they will probably total $12 billion and perhaps up as high as $18 billion or so.” He adds that this is a rough guess so soon after the event. Additional damage can still occur: sinkholes, collapsing buildings with weakened foundations, flood waters still rising in already swollen rivers.

Asked if some risks could become uninsurable, particularly in coastal areas subject to increased danger of catastrophic flooding, Weisbart says, “As an economist, I would prefer to say that if the market is functioning properly, a company will offer coverage at a cost no policyholder is willing to pay—which would be the equivalent of being uninsurable. In that case, risk would be properly communicated from the prospective insurance company to the prospective insured.”

Advisors, he adds, should be aware of two things: the risks inherent in client portfolios if they invest in insurance, and the need for adequate coverage of risks they may not have considered. While it’s increasingly important to know where an insurance company’s risks lie as an investment, it’s also increasingly difficult. A company might have 5%-10% of the market in a given area, but whether that area is prone to catastrophic losses is a vital piece of information—and so is the type of risk. Vermont, for instance, is not known for the kind of flooding Irene brought. Another aspect of that same issue, Weisbart says, is “that some direct carriers have exposure by offering some reinsurance on the side. So even if their direct line is pretty well protected, there might be risk coming in the back door.”

Weisbart concludes, “You have to recognize [the earthquake and Hurricane Irene] amounted to essentially an invasion of black swans, with a whole flock of them coming by.” However, while it may be an unusual series of events, he points out that “really what’s necessary is an enterprise-wide assessment of risk that each business, small or large, should undertake, and […] a conversation with an agent or broker about what can be done.”  


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