Hurricane Irene is Set to Storm Insurance Company Stocks

As Hurricane Irene makes its way along the East Coast this week and next, insurers (NYSE:KIE) like State Farm could be looking at hundreds of millions of dollars in damages caused by the major hurricane. The hurricane is the first major hurricane to touch the U.S. since Wilma in 2005, and the first hurricane of any kind to strike the U.S. since the Category 2 Ike in 2008.

Already this year, weather-related catastrophes have erased second-quarter profit at some of the nation’s largest insurers, including Travelers Cos. (NYSE:TRV) and Allstate Corp. (NYSE:ALL). Irene could now cost insurers additional billions in policy payouts. Connecticut alone is expected to face almost $700 million in insured losses from the storm, the most of any state, according to estimates from risk-modeling firm Kinetic Analysis Corp. New Jersey and New York’s Long Island are also expected to be hard hit. Travelers and Chubb Corp. (NYSE:CB) are among the top sellers of home insurance in Connecticut, while State Farm has the largest share of the insurance market in New Jersey.

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Already this year, insurers’ (NYSE:XLF) catastrophe losses have totaled a combined $17.3 billion, mostly from tornadoes. Irene could lead 2011 to one of the worst years for insurers on record as it tears through state after state. But Howard Mills, chief adviser of Deloitte LLP’s insurance-industry group, said the insurance industry is in a strong financial position, despite catastrophe losses in the first half of the year. “No one foresees Irene being a major problem for the insurance industry in terms of insured losses,” said Mills.

One reason the nation’s largest insurers aren’t too worried is that state-created entities hold a significant amount of the risk in the more easterly zones of disaster-prone states like North Carolina, where the the Insurance Underwriting Association and the Joint Underwriting Association sold $201.8 million in catastrophe bonds in May, which pay fixed-income investors more than benchmark rates for taking the risk that they could lose their principal in the event of certain disastrous conditions. Agencies like those in North Carolina provide coverage for property owners who can’t buy policies through standard insurance markets. The Insurance Underwriting Association reported 183,646 policies at the end of March, an increase of 53% from 2005, as government-run insurers expand to ensure that Americans have the necessary coverage to allow them to rebuild after a storm.

Private insurers might even have a reason to rejoice, with the storm giving them the excuse they’ve been looking for to raise premiums. After majors storms in 2004 and 2005, insurers were able to dramatically increase rates, but since Ike in 2008, the U.S. has witnessed relatively calm weather by disaster standards, and insurers have been unable to raise rates since then, with strong competition and readily available supply keeping premiums low. That could all change in 2011.

Globally, insurers have lost as much as $90 billion this year — that’s 20% more than in 2009 and 2010 combined — and 2011 looks set to be the costliest year in history for insurers around the world. At this point, even a relatively small storm could trigger premium hikes. “It wouldn’t take much of a material event to cause significant firming,” said Gary Prestia, chief executive of the U.S. business at global reinsurer Flagstone (NYSE:FSR). “It wouldn’t take the typical $40 billion Katrina to push this into a firmer market than it is currently.”

If premiums rise, so will insurance companies’ share prices. Property and casualty insurers are currently trading at historically depressed multiples of their book values. At their peak, property insurance stocks should trade at two times their book value, but right now, the sector median is 0.83 times book, which makes them very cheap. Reinsurance companies, which insure the insurers, also benefit from major storms. Share prices in the sector rose an average of about 32% in 2004 and 20% in 2005. Irene only needs to do $15 billion worth of damage to trigger premium hikes, which will pay out in the long run, even if they result in short-term losses.

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Stocks to Watch: ACE Ltd. (NYSE:ACE), XL Group (NYSE:XL), PartnerRe (NYSE:PRE) Everest Re (NYSE:RE), Travelers Cos. (NYSE:TRV), Chubb Corp. (NYSE:CB), American Financial Group (NYSE:AFG), American International Group (NYSE:AIG), The Allstate Corp. (NYSE:ALL).