How a Small Group of Firms Changed the Math for Insuring Against Natural Disasters

As disasters like the wildfires that devastated the Hawaiian town of Lahaina and the storms that tore apart roofs from Alabama to Massachusetts last week intensify, insurance companies have pulled back from offering coverage in certain areas or cut the kinds of damage they will pay to repair.

A little-noticed slice of the financial industry that provides insurance to insurers, called reinsurance, has helped drive the changes.

These companies promise to step in with cash — usually huge amounts — when something like a hurricane, wildfire or other big disaster creates damage that is too costly and widespread for insurance companies to pay for on their own. And at the beginning of the year, nearly all of them raised prices.

In the weeks leading up to Jan. 1, when about half of reinsurance policies are renewed for the year, reinsurers broke the news to insurance companies across the United States and Canada — from large national carriers like State Farm and Farmers to smaller, more specialized firms — that their prices were going up. That led to a flurry of tense negotiations between those insurers and firms, like Swiss Re, Odyssey Re and other reinsurers, many of whom are headquartered outside of the United States.

Reinsurers have lost money over the last four or five years as they competed to offer the best terms to customers, said Franklin Nutter, president of the Reinsurance Association of America, the industry’s trade group. But late last year, they decided competing this way wasn’t worth the cost.

“The reinsurance community at large essentially decided we need a reset,” said Sean Kent, an insurance broker for FirstService Financial, who helps big housing developments find property insurance policies. “It was the most volatile of any reinsurance renewal date in decades.”

Reinsurers’ increased prices have accelerated changes in an industry grappling with a new sense of uncertainty. The world is warming; storms are getting more intense; inflation has increased the cost of rebuilding after a disaster; and a global increase in interest rates is making money itself more expensive.

Since the beginning of the year, insurance companies have paid out $40 billion to U.S. customers, putting them on track for another record in yearly losses. At every level, the costs of guarding against risk are rising and everyone, from the leaders of large companies to the owners of homes and small businesses, is feeling the squeeze.

“If you’re a C.E.O. or C.F.O. of a mid-market company — we’re talking about a 500-unit townhome community in Minnesota — they’re talking about reinsurance and the impact that reinsurance has on their bottom line and their profitability,” Mr. Kent said.

Prices for reinsurance rose as much as 40 percent on Jan. 1 from a year earlier, according to a report by Gallagher Re, a brokerage firm that puts together reinsurance coverage deals. The price increases jolted insurers, who then made changes to where and for what they offered coverage. When State Farm announced in May that it would stop accepting new applications for certain policies in California, it cited “a challenging reinsurance market.” Allstate also cited reinsurance costs when it paused some of its activities in California. Last month, reinsurers specializing in agriculture insurance announced that they were pulling out of Iowa, where, three years ago, a severe windstorm caused nearly $4 billion in damage.

As a result of rising reinsurance costs, insurers also raised prices where regulations allowed. The cost of insuring big new developments of stick-frame housing, the kind springing up at the edges of cities like Denver and Calgary, Alberta, and across the Texas plains, skyrocketed, according to Mr. Kent.

Severe thunderstorms in the United States have caused nearly 70 percent of the losses that insurance companies around the world have incurred this year from natural disasters, according to an Aug. 9 report by the Zurich-based reinsurer Swiss Re. And the weather is not likely to get better.

“We are very likely going to see 2023 be the costliest on record for thunderstorms in the United States,” said Steve Bowen, Gallagher Re’s chief science officer.

To industry outsiders, it might seem strange that so many reinsurance companies, based in different parts of the world, would behave so similarly. But in the insurance industry, such herdlike movements are common, according to Michael Powers, a finance professor at Tsinghua University in China and a former deputy insurance commissioner for Pennsylvania.

“People in the industry tend to be risk averse, they tend to be looking at the same data, they tend to see the world in the same way,” Mr. Powers said.

Many industry experts, including Mr. Nutter, think reinsurance prices will stay high for a significant period. They say insurers may have to raise prices even in places where they meet the most resistance from regulators, who generally review price increases on consumer insurance policies and have the right to block those they determine would generate excessive profits.

As reinsurers pull back, some insurance companies are turning to other methods of securing backup cash. One, the market for catastrophe bonds, lets investors put up money that can be used to cover major-disaster losses in exchange for small regular payments that can add up to an appealing investment return. A total of $7.1 billion in catastrophe bonds were issued during the second quarter of this year, a record, according to Artemis, a company that tracks the market for the bonds.

But not all reinsurers have backed away from insurers in areas facing increasing risk from natural disasters. The reinsurance business of Berkshire Hathaway, the conglomerate owned by Warren Buffett, recently made a $1 billion deal with Florida’s state-run insurer, Citizens Property Insurance Corporation. It is Citizens’ largest coverage agreement to date with a single company for traditional reinsurance.

Mr. Powers said that reinsurance prices could come down sooner than most people are expecting, and that reinsurers will stay away only for so long before they start to feel that they’re missing out.

“People realize the sky hasn’t fallen,” he said, “and they want to make money.”