Saturday, September 03, 2005
Foreseeable Economic Reverberations in the aftermath of Hurricane Katrina
In the wake of Hurricane Katrina that has destroyed and devastated much of the American Gulf coastline, two issues become apparent. The first is the human issue, the tragedy that has involved residents of New Orleans, Mobile and the other Gulf cities affected by Katrina. This human issue is presently being taken care of by the authorities and we certainly hope and wish that the lives of all affected individuals will return to normality as quickly as possible. The second is the economic issue and this will take a while to unfold.
The economic issue can be broken down into three parts: the cost to the insurance industry in terms of forthcoming claims, the reconstruction phase that will necessarily begin once the situation is normalized and which will involve real estate and the handling of interest rates and, last but not least, oil and the cost of gasoline.
The insurance industry tracks catastrophes to monitor claim costs, assigning a number to each catastrophe. Each claim arising from the event is tagged so that total industrywide losses can be tabulated. The term catastrophe is often used in the property insurance industry in a narrow way to mean a catastrophic event that exceeds a dollar threshold in claims payouts. This figure has changed over the years with inflation and the increase in development of areas subject to natural disasters. The term “catastrophe” in the property insurance industry denotes a natural or man-made disaster that is unusually severe and that affects many insurers and policyholders. An event is designated a catastrophe when claims are expected to reach a certain dollar threshold, currently set at $25 million.
Before the 2004 hurricane season, the 9/11 terrorist attacks ranked as the most costly U.S. catastrophe in terms of property damage alone at $18.8 billion — more when liability claims are included. The insured losses caused by the four hurricanes that struck Florida and other East and Gulf coast states in 2004 is estimated at $22.9 billion, exceeding 9/11 property damage. The 2004 hurricane season resulted in more than two million claims, far more than the 750,000 claims filed after Hurricane Andrew in 1992 which is the industry’s single most costly natural disaster to date. By comparison Hurricane Katrina, the 11th storm of the Atlantic hurricane season, hit South Florida as a Category 1 hurricane on Thursday, August 25 and headed out to the Gulf of Mexico. There it gained strength and turned northward, at times generating winds in excess of 160 mph. It hit the mainland early in the morning of August 29 just east of Grand Isle, Louisiana, as a Category 4 hurricane. High winds and the wall of water caused by the storm surge completely destroyed large sections of commercial and residential development along the coast and left hundreds of people dead. Initially it was thought that New Orleans had been spared but some dikes caved in and water has flooded the city. It is too early to estimate insured damage. Estimates so far have ranged from $9 billion to $30 billion with some projected estimates topping $60 billion. States with the most damage are Louisiana, Mississippi, Alabama and Tennessee.
How does the insurance industry deal with extraordinary costs such as the $30 billion bill for Hurricane Katrina? The insurance industry is intertwined nationwide in the United States and Canada. It is estimated that 65 percent of Homeowners Policies underwritten in Canada are carried by insurers in part or wholly financed by American underwriters. The 2004 hurricane season generated a turmoil in the industry with premiums in Canada increasing between 20 to 30 percent depending on the Province. It is projected that the aftermath of Katrina will cause an even higher premium increase in the forthcoming future.
Real estate and the reconstruction of the affected areas will take months to unfold and years to complete. The flooding has displaced about one million workers in the Gulf Coast region, many of whom will not be able to resume their jobs anytime soon. Rough estimates indicate to 200,000 the number of single-family dwellings that need to be gutted and remodelled, if not re-built outright from scratch. In a sign that the recovery could make the sprawling construction sector even busier than it has been during the recent housing boom, the price of lumber jumped last week. The normal pattern is that after the negative consequences the economy gets into a rebuilding mode, and that rebuilding mode takes to higher G.D.P. levels. If this model holds true, the Gulf States are going to be the next real estate Mecca in the forthcoming future.
And what about oil ? Economists say that the storm and its aftermath has raised the risks of a downturn. One major question is whether the damage to oil refineries aggravates what had already been a growing burden caused by soaring energy prices. No forecaster knows how consumers will react to seeing gas lines reminiscent of the 1970's and hearing the President urge people to drive less. If oil production or refining does not return to pre-storm levels for months, a spike in energy prices could prompt households to cut their spending and cause other hardships. Most predict a slowdown in growth during the rest of this year and a pickup next year, as New Orleans and southern Mississippi are rebuilt.
Taken altogether, the three parts of the economic issue make the Fed's job really difficoult when it comes to interest rates. The Fed has been raising its benchmark interest rate since the start of last year to ward off inflation, a policy that will probably continue. But talking about economic models, the problem is that every recession since 1971 has been preceded by two things: 1) higher oil prices and 2) an increasing Federal funds rate. Consumers also have less of a cushion than they have had at many other points. In fact , with the nation's savings rate falling practically down to zero in 2005 in both the United States and Canada, households have little ability to absorb higher oil prices without cutting other spending. Converging forces are, therefore at work to pull the Central banks to either raise interest rates to cool a hyperinflated reconstruction economy and to spur a downturn fueled by rising oil prices. It is going to be very interesting to see which direction will be taken in forthcoming months.
Luigi Frascati
Real Estate Chronicle
