The sand went first. As the waves of Hurricane Ophelia pounded Emerald Isle in September, thousands of tons of it, pumped onto the eroding beach in recent years, vanished back into the thrashing Atlantic. Then came more than a foot of rain. The roof caved in at Emerald Isle Video in K&V Plaza, a strip shopping center owned by Coastal Land Ventures. Then, when wind gusts hit 90 mph, the roof of Bell Cove Village, another shopping center Coastal was building on the island, began to flutter. “The wind just got up under it and lifted it off,” says Larry Watson, vice president/secretary and half owner of Coastal.
After two days, the storm passed. It left behind in North Carolina $35 million in insured damages, says Jersey City, N.J.-based Insurance Services Office. Coastal’s losses totaled about $100,000. But for Watson, a 56-year-old shopping-center developer, and hundreds of Tar Heel business owners like him, insurance checks will come with a catch.
Ophelia might rate only a footnote in the nation’s worst hurricane year, but another storm, Katrina, with $60 billion in damage along the Gulf Coast, will force many business owners to give back some of their claim checks. For some, the pinch could come next year.
“My annual premium on all my centers is in excess of $100,000,” Watson says. Coastal owns about a dozen small shopping centers on the island. “That covers wind and hail, general liability and fire. When they all come up for renewal, which will be in 2006 sometime, they’re going to be quite a bit higher.” Watson’s agent has warned him it could be at least 15%.
Nobody knows how severe increases will be, but there are hints. Homeowner rates in coastal counties had jumped 15% in August, prior to Katrina. In October, North Carolina Farm Bureau Mutual Insurance and Allstate, the third- and fourth-largest home insurers in the state, said they would cut back coverage in coastal counties. That could signal similar cuts or premium increases in commercial insurance.
Some insurance insiders say the clout of Katrina, Wilma, Ophelia and other storms might be less than the flooded streets of New Orleans and devastated coast of Mississippi suggest. They paint a picture of an industry that learned lessons with its chin — for instance, Hurricane Andrew in 1992 taught companies to quit concentrating coverage in compact areas — and had muscled up financially, thanks to a stronger stock market and higher surpluses.
“Property-and-casualty insurers were on track for only the second underwriting profit in 26 years,” says Robert Blumber, a managing director at Marsh Inc., a subsidiary of Marsh & McLennan in New York. And with some exceptions, such as Coastal’s property coverage, premium increases will be spread over years rather than months.
Nobody expects businesses to get off unscathed. Who in North Carolina is most likely to see rate increases first? Commercial-property owners, whether they’re small like Coastal or national behemoths. “People that own shopping centers,” says Harold Wilkerson, who manages commercial coverage for Wachovia Insurance Services in Charlotte. “People who own, say, a couple hundred million dollars worth of property that’s either commercial or office structures across Florida, Texas, the Gulf Coast.”
Extra costs might also show up in ways other than steeper premiums. Wilkerson says increased rates could be accompanied by higher deductibles. In a trend similar to that in health coverage, where employers have shifted costs to employees through higher co-pays and deductibles, businesses could be required to absorb higher out-of-pocket costs. “Before Katrina, we could see wind deductibles for coastal properties anywhere from 2% to 5% of the property value. What we’re hearing now is that those are going up from 5% to 10%.” Watson’s agent has told him that Coastal’s deductible will be $5,000 on a shopping center he’s building. It was $1,000 on earlier ones.
Some Tar Heel business owners also could feel Katrina’s kick when their carriers restrict coverage, similar to the moves by Farm Bureau Mutual and Allstate on home insurance. That could tighten the market and drive up costs. Typically, such pullbacks are temporary and wouldn’t make it impossible to find coverage. In North Carolina, wind-and-hail coverage for coastal businesses and homes is sold through an insurance pool the General Assembly established in 1969 to encourage coastal development. It’s similar to the uninsured-motorist pool for high-risk drivers.
The pool covers the barrier islands and 18 coastal counties. The North Carolina Insurance Underwriting Association, known informally as the Beach Plan, is funded by 300-plus companies licensed to sell property-and-casualty insurance in the state. Intended as insurer of last resort, in reality it insures almost everybody on the coast — homeowners and business owners — against wind and hail. Rates are set by the fund and approved by the N.C. Department of Insurance, not negotiated through a broker as with most big-business coverage.
“It’s pretty much locked-in fees,” says Watson, who buys his wind-and-hail coverage from the Beach Plan. “You can’t bid it out unless you go to someone like Lloyd’s of London, which is extremely high.” Lee Dunn, Beach Plan assistant general manager, says Katrina won’t directly affect rates because it didn’t hit North Carolina. No rate changes had been approved by late October.
If the Katrina toll on Tar Heel business bankrolls seems muted, an inside look at the arcane workings of how the insurance industry manages its money and risks helps explain why. Give thanks, experts say, to good timing and good luck.
Claude Lilly, dean of the Belk School of Business at UNC Charlotte, was director of the Center for Risk Management and Insurance Research at Florida State University when Andrew hit in 1992. “One of the mistakes some of the companies made in Florida, especially before Andrew, was that they wanted to have large market share,” he says. “They’d try to write all of the homes within eight or nine or 10 ZIP codes.”
Companies bet on reaping savings from efficiency while underestimating the likelihood of catastrophic or repeated losses in the same place. They lost. “The problem is, if a hurricane comes through and it happens to hit your ZIP codes, you’re just going to take a real shock to the bottom line. Since then, the industry has spread out a little bit.” As for the Katrina effect in North Carolina, “you’re going to see some increases” in rates, Lilly says. “If you get farther inland, you’re going to see less increase.”
Another unanswered question that could affect insurers — and pressure them to increase premiums everywhere — is the issue of flood versus wind. Some business owners call it the battle of the small print. Mississippi wants insurance companies to pay for flood damage even though it’s excluded from policies. Owners con-tend that most losses were caused by an inseparable combination of wind and flood. If insurers lose the battle in court, they could have to swallow billions in unanticipated payouts.
Other costs aren’t yet fully known. “In Andrew, some of the greatest losses were due to business interruption, not damage to property,” Lilly says. The meter is running on thousands of those claims. But delays in settling them and resolving the flood-or-wind dispute will help spread the impact of Katrina and relieve pressure on insurers to quickly raise commercial premiums. Two Wachovia insurance specialists say the industry won’t try to make up the lost $60 billion in a single year.
“They’re not going to take it all back in one fell pricing change,” Wilkerson says. He and Gene Link, Wachovia Insurance Services regional manager in Charlotte, pre-dict rates will stay about the same in 2006. “We don’t think that anybody’s going to be looking at sticker shock as a result of this for ’06,” Link says. “We don’t see this turning the marketplace.”
As for timing, Katrina hit when many insurers were relatively flush. “This is not by any means going to wipe out reserves,” Lilly says. Rating agency A.M. Best calculated the industry surplus at $408.1 billion before the hurricane. Moreover, insurance companies, which in years of heavy payouts might earn all their profits from Wall Street investments, were benefiting from strong equity markets in recent years.
One other safety valve was in place — reinsurance. Sold by a handful of companies, most based in Bermuda and Europe, reinsurance lets insurers take on huge risks, then spread some of it by insuring themselves against losses over a set dollar value. Among North Carolina’s most notable links with reinsurance was Burlington-based Fortress Re. One of the nation’s largest reinsurers, it was driven into insolvency by losses and lawsuits stemming from the 9/11 terrorist attacks.
Reinsurance costs for insurers are expected to rise in Katrina’s wake. But there, too, is a built-in delay. Though some insurers may jack up customers’ rates in anticipation of increased reinsurance costs, others will wait until they sign new contracts. Chad Shields, a senior vice president with Marsh in Charlotte, says business owners won’t get a clear picture of the impact of rising reinsurance costs until they renew policies in January or, in some cases, June.
Rates also will be affected by how insurance companies reconstruct their catastrophe models — the proprietary worst-case scenarios they use to price coverage. As was the case with Fortress Re and its 9/11 downfall, models that were in place for New Orleans and the Gulf Coast when Katrina struck proved disastrously optimistic.
Now insurers are likely to be especially conservative — erring on the high side — when they construct post-Katrina models. “Faith in modeling has been shaken by what went on in New Orleans,” Blumber says. But it’s clear insurance companies will charge more for storm-prone property — particularly if it’s protected by levees.
“We’ve already gotten indications across the board that property renewals will go up in 2006 as a direct result of storms,” says Arnold Edwards of Charlotte-based broker Edwards, Church & Muse Inc. Wachovia’s Wilkerson elaborates: “The law of large numbers will be at work. If you can raise everybody a little bit, it makes it easier to manage than to try and find the people who need it and charge them more than they can ever afford.”
On Emerald Isle, Watson was finishing his latest strip shopping center, two buildings of brick and stucco. One will be 12,500 square feet and house a beachwear store and a custard-and-coffee shop. A smaller one will have an Italian restaurant, real-estate office, gift shop and linen service. “I had to put permanent insurance on it,” he says. “It was quite a bit higher than I expected.” But like most business owners, he will pay the premium, and the lesson of Katrina will stick in his mind: The cost of not paying could be higher.