Sectors To Watch: Property & Casualty Insurance
The US financial markets are closed on Monday. However, it’s anything but quiet as Hurricane Sandy bears down on the east coast.
Obviously, the most important thing is ensuring the safety of the 60 million people who will be impacted by the storm. But there’s no doubt, Sandy will have a financial impact as well.
Airlines have grounded thousands of flights. Public transportation has been suspended. And all types of businesses have closed their doors.
The hurricane will certainly have a dramatic impact on the region’s economy. Moody’s economist, Ryan Sweet, pegs the economic impact of shutting down New York City and Washington D.C. at $10 billion per day.
That’s certainly a big impact. But for the most part, the economic fallout will largely be a regional story. It shouldn’t be a drag on US GDP in the 4th quarter.
However, Hurricane Sandy will likely have a major impact on one industry in particular.
Experts are forecasting damages in the neighborhood of $20 billion. But some think the total could balloon to as much as $200 billion.
Obviously, $200 billion of property damage will result in massive claims on property & casualty (P&C) insurance. And those claims will result in huge underwriting losses at many of the largest P&C companies in the 4th quarter.
But that’s just the tip of the iceberg…
Hurricane Sandy has been dubbed a “Frankenstorm”. It’s part hurricane and part nor’easter. And it’s bringing in a mix of rain, snow, and wind that’s never been seen before.
Put simply, Sandy’s the first storm of its kind.
That makes Hurricane Sandy especially troubling for P&C companies.
You see, P&C companies set their insurance rates from actuarial tables. These tables take into consideration the financial impact of risk and uncertainty. They mathematically evaluate the probability of an event and the financial impact associated with an undesirable event (like a hurricane).
But Sandy’s not like anything else that’s ever happened. So it’s impossible for P&C companies to have properly accounted for the impact of this storm.
We’ll likely see P&C companies take much larger underwriting losses than they expected. And the cost of P&C insurance on the east coast will almost certainly go up as actuarial tables are adjusted for the likelihood of another storm like Sandy.
That spells trouble for P&C companies in the weeks and months ahead.
The iShares Dow Jones US Insurance Index Fund (IAK) has about 55% of its holdings tied up in property & casualty insurance companies. And it will likely take a big hit as the property damage totals come in over the next few weeks.
Buying put options on IAK is a simple option play to speculate on a downturn in P&C insurance companies in the wake of Hurricane Sandy.
Good Investing,
Corey Williams
Category: Options Trading
