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Insurers are getting nervous as Hurricane Laura is set to make landfall as a powerful Category 4 storm

August 26, 2020, 5:49 PM UTC

With Hurricane Laura forecast to make landfall tonight as a potentially catastrophic Category 4 storm somewhere along the Louisiana-Texas border, insurance companies are bracing for losses.

Based on the current forecast storm track, it looks likely that Houston will be spared a direct hit from Laura. That’s important because insured losses are largely determined by population density and property values.

Insurance industry insiders have been discussing estimates of insured losses that range between $10 billion and $20 billion, according to a report on Artemis.bm, a website that tracks activity in the market for insurance-linked securities. These are financial instruments that insurers and reinsurance companies use to hedge their own risk—and which specialized funds and hedge funds often invest in for their potential outsized returns.

But if the storm shifts west at the last minute and comes closer to Houston, insured losses could rise dramatically. Hurricane Ike, a Category 4 storm that hit Houston in 2008, caused about $20 billion in insured losses in today’s dollars. Harvey, another Category 4 hurricane, that struck the region in 2017 caused damages far in excess of that after the storm stalled after making landfall, inundating the region with days of heavy rain.

Even losses in the low double-digit billions will spell trouble for the insurance industry, according to Credit Suisse analysts.

In a report published earlier this week, the Swiss bank said that losses in this range from Laura, coming on top of damage from Hurricane Isais earlier this month and the unusual “derecho” storm that pulverized the Midwest, the on-going California wildfires, as well as recent events like the devastating explosion in Beirut, was likely to completely exhaust the money that reinsurance companies had budgeted for catastrophes this year.

The analysts said that most reinsurance companies would likely be able to rebuild their balance sheets through higher premiums next year. But some property and casualty insurance companies could struggle to recoup any losses, the bank said.

Industry insiders also think that the COVID-19 pandemic may make things worse, because some loss adjustors are reluctant to work in areas with high infection rates. In general, delays in getting loss adjustors on the scene of a disaster increases the total cost of insurance claims.

Those factors have lead to a surge in trading for catastrophe bonds in the past few days, according to Artemis. Catastrophe bonds are issued by reinsurance companies as a way to hedge some of their own risk from devastating hurricanes, fires, floods and earthquakes. The bonds pay a high interest rate—often between 7% and 15% per year—but if the insured losses from a particular event exceed a specified threshold, the creditors lose their entire principle.

Inverstors have also been scrambling to trade a different kind of insurance-linked security called an industry loss warranties, according to Artemis. These are derivative contracts that an investor, usually an insurance company, can buy as a way of further hedging their risks from natural disasters. The contracts pay the investor an agreed amount if the total insurance industry losses from a certain event exceed a specified level.

For instance, an insurance company might want to buy a contract that will pay them $100 million if the total insured losses from a Gulf hurricane striking Texas or Louisiana exceed of $20 billion. But the investor pays the underwriter on the other side of the deal, usually either a reinsurance company or a hedge fund, a premium for writing the contract—say, 15% of the contract amount, or $15 million in this case—and those premiums are rising rapidly as Laura churns towards the Southern U.S.