This year’s string of devastating natural disasters has put insurers on edge. Earthquakes, tornados, floods and fires have drained capital levels throughout the insurance industry. In an effort to recover from such dramatic losses, many insurers have taken to ramping up their rates. Higher premium rates mean that companies will be able to recover their losses faster, but it also means they stand to make quite a bit of profit. This has not gone without notice, as investors begin flocking to the industry, seeing opportunity in the rampant calamity.
“There has been an observable change in investor interest,” says David Flandro, global business intelligence head at Guy Carpenter, a worldwide insurance broker. “So far this year, more than $2 billion of new capital has entered the property catastrophe insurance sector.”
Investors have been wary of funneling money into the sector because of the high risk associated with such action. This has led them to team with experience underwriters from well established insurance companies in the effort of creating finance vehicles often referred to as “sidecars.” The term refers to underwriters crafting premiums that account for the risks they are most familiar with. These underwriters are often rewarded for their work by receiving a cut of the profits earned on new premiums.
Several of these sidecars have been set up over the past few months attached to big-name insurers like London’s Lancashire Holdings and Bermuda’s Validus Holdings.
There is a problem with the rapid influx of investors that goes relatively unnoticed. Inexperienced investors are being attracted to the industry, hoping to make a profit on rising insurance rates. These investors have what insurers call “silly capital,” and their presence in the industry can hurt efforts for recapitalization. As these investors poor money into sidecars, they cause a steep rise in premiums for established insurance companies. New companies take advantage of this by undercutting the prices and taking in the tide of customers fleeing excessive rates.
The problems are often understated, says Flandro, as few outsiders believe that big organizations like insurance companies are susceptible to exploitation.