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CAT KAT's Slap of CAP Markets
Hurricane Katrina, the greatest insured loss in history, laid bare more than the Gulf Coast. It also revealed the workings of various corners of the global capital markets.
The storm demonstrated what an extraordinary business insurance, and particularly reinsurance, is. Many large reinsurers lost a quarter to a half of their capital that August weekend. Planning, or something like it, for such events is their job: to be storehouses of wealth in good times, suppliers of reconstruction capital following major physical upheavals. That means, for property/casualty reinsurers and others that reinsure high-cost, low-frequency events, making excellent returns in a hard market and then taking losses measured in billions of dollars. Reinsurers are the bedrock on which the economic system is built, yet they are among the most inherently volatile of all publicly owned businesses. Companies that speculate in derivatives, foreign currencies and other high-risk/high-reward activities are usually privately owned. When Permanence Re loses its shirt on a hurricane, it's actually losing the buttons off your pension's shirt.
The foregoing contains a degree of simplification, but not much. Following losses of $600 million to $700 million from Hurricanes Katrina and Rita, ACE raised $1.5 billion in new share capital. It doubtless took more than a couple phone calls--meeting schedules must have been horrendous for all concerned--but it took only one call to set the ball in motion. When the global capital system takes a hit of, say, $60 billion, the inexorable laws of money management direct as much as is lost or more to cover the gap and anticipate the alpha of investing in a rising market. A question asked whenever fast billions are raised is: What was this money doing before? Equity is raised, via merchant banks, from the public, which always has a few spare billion to invest in a sure thing. The banks also supply loan capital. Venture capital floats around, sniffing out unusual opportunities. Reinsurance, by this logic, can be seen as a funnel of ever-increasing size through which investor dollars are processed, over time, into claims. In other markets, one phone call is all it takes to buy or sell a "live cat." Some hedge-fund managers, apparently, see the opportunity for real profit by betting against a storm that is, say, 24 hours from Houston, only one day away from great harm. In horse-racing terms (the analogy is closer than you think), this is like betting against the clear leader two furlongs out. Hurricanes, of course, are less reliable than racehorses, but the hedge funds' bet is not against the storm--it's against the weather forecasters. Reinsurance buyers under such circumstances hope that the storm will turn away at the last moment and do only minimal damage, in which case the hedge fund earns a hefty premium without matching losses. Reinsurers, presumably, go straight to church to thank the God of their choice for hedge funds, regardless of the outcome. By "markets," of course, I mean people. That's all markets are. While events may not be predictable, people are. The markets work because money has its own rules, which humans follow, almost slavishly. Thank goodness. ROGER CROMBIE, a writer, editor and former accountant, is a regular columnist for Risk & Insurance®. He also covers issues on alternative risk. December 1, 2005 Copyright 2005© LRP Publications |
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