For US insurers, the first half of this year was one of the costliest on record, following a series of twisters, tropical storms and hailstorms. Weather experts are expecting worse to come on both sides of the Atlantic.

In June, Tropical Storm Allison whipped over the gulf and east coast of the US, generating torrential rain and causing severe flooding, as many rivers exceeded their projected 100-year flood levels. According to the National Climatic Data Center, total losses – insured and uninsured – will reach almost $5bn (£3.5bn), making it the most expensive tropical storm since Hurricane Andrew in 1992.

Swiss Re says the losses have already exceeded some insurers' catastrophe reinsurance protection.

These losses follow last year's extensive flooding in Northern Europe and Japan, which produced record insurance claims. The Association of British Insurers (ABI) says claims in the UK alone cost almost £700m. In Taiwan, two typhoons recently ripped through the island, bringing 80cm of rain in one day and killing more than 200 people.

Swiss Re expects the trend towards higher losses to continue. It points to the effects of climate change, higher concentrations of values in areas exposed to natural hazards and increasing population densities. In 1950, New York was the only city with more than ten million inhabitants. Now there are 20 such cities, 16 of which are in the developing world.

Flooding normal?
In the UK, the Environment Agency has highlighted the evidence of increasing winter rainfall and has urged the two million householders and 100,000 businesses situated in flood-prone areas to be prepared to treat flooding as a normal seasonal hazard. And ABI members have agreed to give the government two years to improve flood defences before they restrict flood cover in vulnerable areas. A report prepared for the Department for Environmental, Food and Rural Affairs (DEFRA) reveals the government will need to double its planned spending on flood defences to provide adequate protection.

A further worry for insurers is that scientists at the National Oceanic and Atmospheric Administration's (NOAA) Climate Prediction Centre indicate a 40% probability of above-normal hurricane activity in the Atlantic this year. They base this prediction on sea surface temperatures in the central Pacific, which are rising to their highest levels since the El Niño episode in 1997 to 1998.

El Niño” means “The Little Boy” or “Christ Child” in Spanish. It was first used to describe unusually warm waters in the Pacific by South American fishermen, who noticed the occurrence near the beginning of the year.

Researchers studying coral in the Pacific have found that, over the past 150 years, the frequency of the El Niño phenomenon has increased from once every ten years to once every four years as a result of global warming. NOAA scientists expect sea level temperatures in the Pacific to continue to rise into early 2002, bringing the prospect of devastating droughts in southern Africa and powerful hurricanes in the Atlantic.

The most destructive El Niño on record occurred from 1982 to 1983. Economic losses topped $8bn (£5.5bn) worldwide and 2,000 people died in flooding, mudslides, droughts and fires.

With the prospect of mounting weather losses, Swiss Re and Tokio Marine and Fire Insurance Company recently swapped $450m (£312m) of catastrophe risk exposure. As part of the deal, Swiss Re will lay off $150m (£104m) of storm exposure in France in return for a similar exposure to typhoons in Japan. This allows both companies to transfer “peak risks” off their balance sheets and involves risk exchange rather than traditional reinsurance.

Swiss Re director Jurg Stoll says: “Swapping exposures is a win-win situation for both companies. Swiss Re and Tokio Marine will both benefit from a diversification effect, which will lower capital costs substantially and increase shareholder value. It is part of Swiss Re's strategy to more actively manage the risk portfolio and optimise capital at risk.”

Increases on the rise
Following five years of falling catastrophe reinsurance prices, premiums rose, on average, by 16% last year, according to figures from Swiss Re. Even before the attack on the World Trade Centre, most observers were forecasting further substantial increases during the 2002 renewal season, as reinsurers apply a more disciplined approach to pricing.

Employers Re Group global chief underwriting officer Hoyt Wood says: “We talk more about returns on our book of business than we do about price increases. Our mantra is risk-based pricing. We put risks through an exposure rating model as well as an experience model. All proposals go through a thorough process of peer review by underwriters and actuaries as well as senior executives.”

Pressure on profits
The double whammy of increasing losses and rising reinsurance costs will put further pressure on insurers' profits. Insurers will need to increase their own prices across most classes of insurance.

However, a report by independent market analyst Datamonitor shows they may encounter stiff consumer resistance. Datamonitor points out that, in 1999, household premium income slumped by 3.4% as insurers struggled to impose price increases of around 2%. With a need for substantially larger increases, many more consumers are likely to forgo insurance if they perceive the cost to be too high.

New entrants in the insurance market, who are not saddled with historical claims and who can cherry-pick risks outside flood-prone areas, are likely to limit other insurers' ability to increase rates.

At the global risks end of the market, analysts expect the use of captives to increase. According to Best's Captive Directory, the number of captives has continued to rise despite soft market conditions. As insurers try to hike up premiums, the business case for using a captive will be even stronger.

With a further surge of weather-related claims on the horizon, increased reinsurance costs, stiff competition and a resistance by consumers to accept pricing increases, the long-range forecast for insurers is not good.