In the fallout from the US's worst ever hurricane season, Bermuda's insurance industry could be left facing the financial and legal consequences. Michael Dobias and Graham Brown report

The physical impact of hurricanes on the southern US was clear for all to see. But as new catastrophes grab the headlines, the long-term financial impact of this summer's losses on the insurance industry is only just beginning to become clear.

No one knows what the final cost of the various hurricanes will be. Some put it between $60bn and $100bn. What is certain is that Katrina will be the single largest insurance loss in US history arising from a natural disaster.

Such was its impact that the date by which insureds have to make claims arising from Katrina has been postponed, and measures put in place to deal with renewal of cover.

Inevitably legal actions have begun, possibly the most notorious being Mississippi attorney general Jim Hood's precipitous attempt to have the state courts of Mississippi disallow any policy exclusions relating to flood damage.

While most of the primary insurance (certainly as regards property damage) will be with US carriers - as well as a significant element of the reinsurance - Bermuda is watching developments with concern.

As one of the world's largest insurance and reinsurance markets, Bermuda is in the eye of the financial storm from this summer's hurricanes.

Estimates suggest that around 32% of the final Katrina losses will end up in Bermuda, putting it second only to the US and more than the rest of the world (including London) combined.

Katrina consequences
Hardly a day passes without new stories about the consequences of Katrina on the Bermuda insurance industry.

Companies are posting reserve warnings, the rating agencies are posting warnings about some companies while downgrading others, with all the knock on consequences that this entails for the company concerned. The hurricanes will have the result of tipping the balance for a few and run-off or insolvency will result.

As to the claims arising out of the hurricanes, while there is no doubt that there is a significant volume of legitimate losses, the adjustment of those losses will be carefully scrutinised both on the island and elsewhere.

With regard to Katrina, we anticipate that many of the old familiar arguments with regard to the number of events or occurrences and the ability to aggregate losses will arise. Katrina struck the coast of Florida some four days before it hit New Orleans.

There may be issues raised as to whether it was the hurricane that was responsible for the breach in the levees and whether the subsequent losses were truly windstorm or flood.

Bermuda reinsurers will be considering jurisdiction, choice of law, and payment provisions in the policies which they wrote in order to assess the scope and extent of their exposure.

They will then be comparing these to the similar provisions in their outwards retrocession protections.

Assuming that the Bermuda reinsurers' own protections are sufficient and broadly speaking written on the same basis, then these losses (once properly adjusted) should be recoverable from their retrocessionaires wherever they may be based.

Questionable claims
If the US courts start allowing more questionable direct claims such as those for flood damage in the face of a flood exclusion, that is the real threat which the Bermuda reinsurer faces.

In this regard the Bermuda market may be either the first line of defence or the innocent party caught in the middle of the financial disaster.

In the action started by Hood, his pleadings suggest that the flood exclusions are against public policy or in some other way unconscionable. This appears a strange argument to those divorced from the immediate impact of the events.

Separate flood cover was available so why disallow the exclusion and in a perverse way punish those with the foresight to buy that cover? Equally, it would appear that if the courts of a state can apparently declare an exclusion invalid almost on a whim, reinsuring business in that state becomes an extremely hazardous exercise.

If Hood succeeds, then forecasts suggest that it will add billions of dollars to the Katrina losses, which either the insurer or reinsurer may not then be able to recover.

Already primary insurers are preparing for the fight, seeking to have the claim heard in the federal court.

Reinsurers will be fully behind every effort made by primary insurers and it is only if these attempts fail that a division of interest is likely to occur.

That said, in his most recent pronouncements, Hood says that he is confident of success and expresses some surprise that insurers are not seeking to negotiate a compromise with him.

It is the prospect of either a compromise or adverse findings that causes great concern to the Bermuda reinsurer, especially a reinsurer whose reinsurance may be governed by the same state law.

Trying to persuade a court in the southern US that has just imposed a flood liability on a US insurer in the face of an apparent exclusion that the insurer is not in turn entitled to recover from its reinsurer, will, inevitably be a difficult proposition whatever the terms of the follow the fortune clause.

Trying to persuade a Bermuda or London-based arbitration tribunal applying Bermuda or English law that the flood damage losses were never intended to be covered by the reinsurance policy and should not therefore be recoverable is a far more realistic prospect.

However, the Bermuda insurance and reinsurance market is nothing if not adaptable. And as strategies are being put in place to deal with the underlying claims, so alternatives for the future of the market are being considered.

Reinsurers are already indicating that there will be vehicles established to take the market forward with new capital and those vehicles will be unburdened by any Katrina liabilities.

Indications are that while the hurricane losses will inevitably lead to some hardening of rates, that may not be as significant as first envisaged. IT

' Michael Dobias is a partner and Graham Brown an associate within Davies Arnold Cooper's insurance and reinsurance group