Can the insurance sector weather the storms?

David Wilkinson - Senior Fixed Income Analyst

High profile weather events such as the devastating Hurricane Milton in the US and the intense flooding in the Valencia region of Spain have drawn attention to the expected catastrophe losses in the insurance sector. These disasters come in addition to a long list of catastrophes in 2024 ranging from wildfires in Alberta, Typhoon Yagi in southeast Asia, the collapse of Baltimore’s Francis Scott Key Bridge, and at the very start of the year the magnitude 7.6 Noto earthquake in Japan.

Catastrophe losses on the rise

According to Aon Reinsurance Solutions the total for insured losses from natural disaster events in 2024 will likely exceed the 2023 total of $125bn.¹ This year will mark the seventh year in the last eight where insured losses are in excess of $100bn, and according to Swiss Re growth in insured losses have outpaced global GDP over the last 30 years and will continue to do so in future.²

Part of this growth can be explained by higher economic losses, estimated by Aon at $258bn for the first nine months of 2024, as property assets increase in value and concentration, including in higher risk areas such as floodplains or coastlines. The impact of climate change on the severity and frequency of major weather events has so far been small, say Swiss Re, but will likely increase in future.

The other component of insured losses is the degree of insurance coverage. The protection gap, the difference between total economic losses and insured losses, was estimated at 60% for 2024 so far. This is relatively low compared to history, reflecting the fact that many events occurred in North America where insurance penetration is higher. The protection gap globally remains substantial, and efforts to extend insurance coverage to those emerging markets with low penetration and a high exposure to climate risks will inevitably increase the magnitude of industry losses.

What do insured losses mean for investors?

A core competency for an insurance company is to estimate and budget for claims and losses, including those arising from hard-to-predict major catastrophes. Several large players have recently revealed that cat losses have come in over budget. Munich Re announced that higher than average major claims, led by Hurricane Helene, would result in net income coming in significantly below the market consensus expectations for the third quarter.³ Other major insurers had similar experiences, and these are before accurate estimates are possible for Hurricane Milton, which will be a fourth quarter event.

It is important to put these headlines and losses in context. All of the major insurance groups are expected to remain profitable for 2024, even after increased estimates of natural catastrophe claims. Higher losses from catastrophes are naturally offset by earnings from other lines of business, including life and health insurance, and by investment income particularly as interest rates are now higher. Furthermore, high levels of industry claims typically lead to insurers and reinsurers being able to put up prices, supporting profitability for the next year. The next round of renewals in the reinsurance sector will take place in January 2025 and is a closely watched market event.

For credit investors there is additional comfort in these companies' robust capitalisation. As regulated institutions they are required to hold sufficient capital to pay out claims over a 12-month period, which for groups regulated in the EU, or equivalent regimes, is calibrated to ensure they can withstand a one in 200 year event. For the majority of insurers the amount of capital held is significantly above this level.

The role of insurance in portfolio construction

The risks facing the insurance sector are distinct from and largely uncorrelated to those in the banking sector, potentially providing a valuable source of diversification for fixed income portfolios.

Insurance companies do not issue bonds with the same frequency as banks, because the business model does not require the same level of wholesale market funding as commercial banks. Banking comprises 17% of the ICE BAML US Corporate Index, while Insurance is 5%, and Property & Casualty insurers less than 1%. But in our view those bonds that do exist provide interesting opportunities to take financials exposure away from the banking sector. This is particularly true at the subordinated level where many insurance bonds offer similar or wider spreads to bank bonds of the same quality.

¹ Aon “Q3 Global Catastrophe Recap” October 2024

² Swiss Re “Natural catastrophes in 2023: gearing up for today’s and tomorrow’s weather risks”

³ https://www.munichre.com/en/company/media-relations/media-information-and-corporate-news/media-information/2024/media-release-2024-10-22.html

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