Under Water Down Under

Australia's floods will be a major catastrophe loss, that much is clear. But it is not entirely clear yet how large an impact the events will have on global supply chains.

By MATTHEW BRODSKY, senior editor/Web editor of Risk & Insurance®

It gets tricky trying to estimate what sorts of insured losses have occurred after a flood event. It's even trickier trying to analyze your flood risk ahead of time, unlike earthquake and hurricane exposure, where you can model what your one-in-10-year loss potential is, or your one-in-100 year.

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Perhaps this explains why reinsurers appear to be caught holding the bag with the Australian floods still ravaging the state of Queensland. News reports suggest that Australia's primary carriers largely transferred the flood losses off their books to global reinsurers. According to Barclays Capital analyst Jay Gelb, Bermuda reinsurers in particular could be hit hard by the estimated $6 billion in insured losses and by the fact that the flood could be divided into two events: a $4 billion loss in January 2011 and a $2 billion loss in December 2010. The reinsurers' fourth-quarter and 2011 earnings estimates are at risk, Gelb said, per newswire sources.

"It is still too early to make an educated comment on the impact on Bermudian reinsurers," is the response to this from Malcolm Steingold, CEO for the Asia Pacific at Aon Benfield.

"The insurance aspect is politically sensitive. Riverine flood is not generally covered under domestic policies, but cover for flash floods is given by some insurers. The Australian prime minister is pushing to define the event as flash flood rather than Riverine flood. Until there is some clarity on this issue, it is premature to comment on the impact on reinsurers," he wrote to Risk & Insurance® in an e-mail.

"The above is exacerbated by determination as to how many events these floods constitute," he added.

Aon Benfield is estimating total economic losses from this event at $20 billion.

Flooding is difficult to model largely because it has in technical terms what is called a much higher hazard gradient, according to Domenico del Re, director at modeling firm Risk Management Solutions Inc. In layman's terms, that means that flood losses are "patchy," with a footprint that is much less defined and harder to predict than other catastrophes. Flooding is determined by which sections of river bank burst and in what sequence. The result is that one block of properties could be completely underwater, while the next block over could be dry.

"If you move that into a hurricane or earthquake context, this isn't the case," del Re said.

RMS has not released a range of potential insured losses for the Queensland floods, unlike it usually does for global CAT events.

Its chief competitor, AIR Worldwide Corp., did, estimating losses from AUD 3 billion to AUD 6 billion ($2.98 billion to $5.96 billion). In doing so, take note, AIR did not base numbers on model output, according to spokesman Kevin Long. AIR modelers instead derived loss estimates on the projected growth of reported claims, the average size of reported claims and insurance industry exposure data it has on file.

More importantly for the commercial property/casualty business, neither AIR nor RMS broke out losses for commercial and industrial properties, especially not when it comes to business interruption and contingent business interruption.

Business interruption and supply chain disruptions perhaps will be felt worst in Queensland's coal mining industry, which is the world's leader in producing steel-grade coal. Recent reports have production down by 10.5 percent for the year ending in June. Reports earlier in January from the Queensland Resource Council had the lost production costing at least $1 billion. As many as 75 percent of the coal mines were closed at one point.

"Business interruption will be a very large component of this," del Re said.

Take the impact one or two or three steps down the supply chain to Asia's steelmakers, and one can wonder what the loss of production will mean for them. One impact pointed out by Bank of America Merrill Lynch, for instance, could be that steelmakers in Asia will pay as much as 78 percent more for their hard coking coal, as reported by Bloomberg.

That's a lot of numbers being thrown around. Instead of modeling, one way to get our arms around them could be to look at historical precedents, said del Re. He suggested looking to the 2008 Queensland flooding event that also impacted the mining sector. Then, the insured hit to mining was $1.3 billion, including business interruption and direct property loss. Some mines took as long as 12 months to restart operations.

"This event was a wakeup call for the mining industry in Queensland," he said.

Since then, the mining firms tried to make their properties more resilient. When the flood waters recede this year, we shall see how well this worked.

January 25, 2011

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