As Hurricane Irma bears down on the continental United States, thoughts are rightly with the homeowners and rescue workers in its path.

The storm is also likely to have profound consequences for insurers. For years now, veteran chief executives and analysts have been warning that part of their sector has a serious problem. New types of investors, lured by the promise of decent returns, have been flooding into the reinsurance market, driving prices down to unprofitable levels.

“The current environment is unsustainable over any reasonable period of time,” Evan Greenberg, chief executive of primary insurer Chubb told the Financial Times last month. “Many companies are not earning their cost of capital — and many are losing money, or will lose money in the future.”

That is obviously tough for Chubb and its competitors. But now that Harvey has swamped Texas, Irma is on the way and Jose and Katia are gathering strength, their problem may well become all of ours.

Reinsurers matter because they provide the back-up policies that help property and casualty insurers make payouts to ordinary people when catastrophes hit. They are particularly important in years when multiple disasters strike and drain front-line insurers’ reserves.

But there has not been that kind of devastation since 2011, when earthquakes hit in Japan and New Zealand, and regulators are worried that some reinsurance providers may have underestimated their risks when setting prices.

UK insurance regulator David Rule recently sounded the alarm, saying “insurers may be underestimating risks, particularly on new business. For example, they may be too sanguine about catastrophe risks, such as significant weather events.”

Willis Re has estimated that insurers are making average returns on equity of just over three per cent, once reserve releases and an abnormally low rate of catastrophes are stripped out. That leaves many of them very little cushion to absorb big losses if they come.

Other investors may also be on the hook for more than they expected. Investors have been flocking to buy insurance-linked securities — better known as catastrophe bonds.

These bonds pay attractive rates of return, but the principal is at risk if the sponsoring insurer needs it to pay out after a specific natural disaster. S&P has identified 13 cat bonds that cover hurricane damage and could be at risk from Irma in this way.

Investors bought $8.5bn in cat bonds in the six months to June 30, breaking the full-year record set in 2007, according to Aon’s brokerage arm.

Up to now, very few cat bonds have ever paid out. But if Irma does serious damage, pension funds and ordinary investors who bought them are going to take big losses. Shareholders of reinsurers are also going to feel the pinch if the costs of cleaning up from the storms squeeze the sector’s already thin margins. If Irma’s path holds, it would “fundamentally change the market,” Willis Re’s incoming chief executive James Kent told an Insurance Insider conference this week.

In a worst-case scenario, some insurers that sold cat bonds may have trouble covering the losses suffered by businesses and homeowners. In that case US taxpayers would be on the hook. The House of Representatives has set aside nearly $8bn for Harvey victims. That number is certain to grow.

brooke.masters@ft.com



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