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Chileans are gradually rebuilding their lives after February’s devastating earthquake, but the work for insurance companies has only just begun.

Insured losses are estimated at between US$5 billion and US$8 billion, or between 16.7% and 26.7% of total damages. The exact amount will not be known until all claims are settled, but the final bill will likely be towards the upper end of that range.

That would make it the second costliest earthquake in terms of insured losses since California’s 1994 Northridge quake and the world’s 11th most expensive natural disaster since 1970.

Chilean insurance firms have already received nearly 200,000 claims for damaged infrastructure and business interruption as a result of the earthquake.

“We are working as quickly as possible to settle claims, but a disaster of this magnitude is unprecedented in Chile,” said Francisco Recabarren, Commercial Manager at the insurance broker AON Risk Services. “This is when you see how good your insurance policy really is.”

AON has 500 corporate clients in Chile including 30% of the top 100 companies in the country and has received claims totaling around US$1.5 billion from clients mainly in the Maule and Bío Bío regions.

“The majority of our clients had an adequate program to cover their risks… not all our clients bought the program we recommended, but the earthquake has made them realize the importance of a good policy,” said Recabarren.

Negotiating settlements could take months but in the meantime insured companies can request an advance on the full amount of their claim to help them get back to work.

While this costs insurers money, in the long run it is cheaper for them to help their clients get back on their feet quickly.

“The sooner a client resumes its normal activity the better for the insurance company because it has to pay less for business interruption,” said Recabarren.

Well Covered

The total reconstruction costs resulting from the earthquake are estimated at around US$30 billion, but the impact on the economy would have been much worse without insurance to soften the blow.

The Chilean insurance market is the fifth largest market in Latin America with overall gross premiums totaling US$6.3 billion in 2009. Nearly two thirds of that was for life and health insurance with Chile’s Property and Casualty Market, known as Seguros Generales, accounting for US$ 2.4 billion, including US$400 million for earthquake premiums alone.

Depending on the industry, over 70% of the cost of property and casualty insurance corresponds to ‘catastrophic risk,’ which includes earthquakes, tsunamis, floods and other natural disasters.

“This is very different from Haiti, which has virtually no private insurance market,” said Robert Hartwig, president of the New York-based Insurance Information Institute.

Chilean insurance companies received 190,195 claims related to the earthquake by the April 30 deadline. As of that date, they had paid out US$249 million, but this number will continue to rise as more claims are settled.

This compares to 5,000 claims and US$85 million in payouts after the country’s last major earthquake in 1985, which covered 7.2% of the damages.

So what has changed in the last 25 years? For one thing, Chileans are better insured. According to the Fitch Ratings report, insurance penetration in Chile is 4.2% of GDP which, while lower than the world average of 6.9%, is nearly double the Latin American average of 2.5%.

“The insurance penetration and density in Chile compares favorably with Latin American countries, but if we compare ourselves to OECD countries, there is still a long way to go,” said Fernando Cambara, president of Chile’s insurance companies’ association (AACh).

For large Chilean corporations and mortgaged properties the penetration of earthquake insurance, which is usually sold as part of the “additional perils” policy issued with fire insurance, is nearly 100%.

Chilean wood products producer Arauco was one of the companies hardest hit by the earthquake and tsunami, which forced it to shut down all its plants and sawmills in southern Chile temporarily. The financial cost, including business interruption, could reach up to US$650 million but, apart from a US$3 million deductible, this will all be covered by insurance.

However, small businesses and homeowners, including many of the old adobe houses destroyed by the quake, were not so well protected.

Of the 4 million homes in the regions affected by the earthquake, only 23.8% of them had earthquake insurance, and 90% of these are mortgaged properties. That means many Chileans face hefty repair bills without the help of insurance money.

“The earthquake has reminded Chileans we live in a seismic country… the percentage of [residential] properties with insurance is low, but we see this tending to grow,” said Cambara.

Risk Dispersion

As in other countries the insurance industry in Chile is build on the concept of “risk dispersion,” which means insurance firms limit their exposure by paying global reinsurers, or underwriters, to take on most of the risk.

Most of the leading insurance companies in the Chilean market are part of multinational groups. Chile’s top five insurance companies by market share are Royal & SunAlliance (18.5%), Penta (11.6%), Mapfre (10.7%), Chartis (9.6%), and Liberty (8.5%), which are all local units of foreign companies except Penta.

But they won’t be the ones footing the bill. “Most of the insurance payments will be assumed by international reinsurers, which means the impact at a local level is much less severe,” said Ignacio Barriga, CEO of UK-based insurer Royal & SunAlliance’s Chilean branch.

As a result, over 80% of the insured losses from the earthquake will be covered by global reinsurers led by Munich Re, Swiss Re, PartnerRe, RenaissanceRe and Hannover Re.

Even if insured losses reach US$8 billion, local firms will end up paying just US$11 million thanks to reinsurance protection, according to a filing by Chile’s securities and insurance regulator, the SVS.

“The solvency of the insurance market is solid and should not be affected by the earthquake,” said the regulator’s head, Fernando Coloma, in the filing.

It helps that the insurance industry is strictly regulated with local insurers only allowed to work with reinsurers that have at least an ‘A’ credit risk rating.

“The insurance market is highly professional, competitive and well regulated,” said Alejandro Hasbun, Associate Director of Fitch Ratings Chile and co-author of a report on the quake’s impact on the insurance industry.

Even though the financial impact on the local market will be limited, insurers could face some cash flow problems since most of the money to settle claims is coming from overseas.

But global reinsurers are well financed and prepared for such a disaster having factored the probability of another big earthquake in Chile into their rates for the last 20 years.

“These are huge companies and Chile is a small part of their overall risk… but they expected an earthquake here at some point,” said Hasbun.

German reinsurer Munich Re will likely face the highest bill from the earthquake at around US$660 million, but for a company with gross premiums of US$54.7 billion and net profits of US$3.4 billion in 2009, this is a drop in the bucket.

“Carrying losses from catastrophes of this dimension is part of our core business,” Munich Re board member and Reinsurance CEO Torsten Jeworrek said in a press release. “We calculate risk-adequate prices for this, and will naturally continue to offer our capacity in Chile.”

Recouping Costs

The earthquake, and other disasters around the world, will hit the bottom line of reinsurers like Munich Re, but the quake is not expected to impact reinsurance pricing outside of Chile.

Within Chile, however, it’s a different story since reinsurers have an opportunity to recover some of their losses by raising prices when reinsurance contracts expire this year.

Local insurance firms can’t afford to be left exposed if another earthquake strikes, so they must replace their reinsurance protection, which means they have to buy coverage from reinsurers – at a higher price.

“The capacity for earthquake insurance in Chile is limited and reinsurers know this so they will likely use the opportunity to raise rates,” said Peter Foley, CEO of local insurance broker Marsh Chile.

In fact, the cost of renewing reinsurance contracts will likely be higher than the cost of the earthquake itself for local insurers, which will in turn pass the price increases on to their clients.

Chile’s insurance brokers say earthquake insurance premiums could rise up to 200% between this year and next. “These are early days still but we expect most companies to face an increase in premiums of at least 20-25%,” said Foley.

Insurance companies can’t be too greedy though. If they raise rates too high, clients could opt to invest their money in other instruments rather than taking out an expensive insurance policy, said AON’s Recabarren.

This is why insurance brokers are recommending insurers do not try to recoup their losses immediately. “As an industry, we have to be prudent and focus on the long term,” said Recabarren.

Even if rates rise in the short term, the increase would only be temporary as more competition in the market should bring prices back down to their normal level within two years, said Foley.

“We’ve seen this before in other disasters… there’s an initial knee jerk reaction as companies raise prices to recoup costs, but then the free market begins to operate, new actors enter the market, and prices are restored,” he said.

However, insurance rates in Chile were “very reasonable” before the quake struck which means there could be some upward adjustment of prices in the medium to long-term, said Foley.

Quake Lessons

Overall, Chile’s insurance market passed the test of the earthquake reasonably well, but there are clearly some areas for improvement.

No one predicted, for example, that the earthquake and tsunami would be followed by rampant looting. Department stores, supermarkets and pharmacies in Concepción lost millions of dollars worth of merchandise in the days following the earthquake.

“Damages due to looting are an on-going debate… are they covered by earthquake insurance or not? This has to be decided on a case by case basis,” said Foley.

Insurers also failed to consider an earthquake could cause damage over such a wide area from Concepción to Santiago. Companies have to pay a deductible of 2% but in most cases the amount for which they are liable is limited. In the future, this ceiling could be eliminated or raised in order to reduce the risk for local insurers.

If that happens, however, local companies could take advantage of Chile’s numerous free trade and double taxation avoidance agreements to buy insurance policies in the U.S. or Europe.

Some companies may feel more comfortable with a Chilean insurer in case of legal issues but “there’s nothing to stop them buying policies outside Chile, especially if taxes are less onerous,” said Foley.

And it’s not just the private sector that could look abroad for protection. In the public sector, many public hospitals, schools and roads were not insured at all, leaving the government with a reconstruction tab of around US$8.4 billion.

In the future, the government could buy insurance or even consider issuing so-called ‘Catastrophe bonds’ in global markets to be triggered in the event of a disaster, suggests Foley.

As for the possibility of a state-subsidized catastrophe insurance program such as the cash-strapped U.S. National Flood Insurance Program, “I don’t see it happening, it would be too costly and the government doesn’t have the habit of subsidizing consumers,” said Foley.

In the long-term though, the earthquake could lead to government measures to increase insurance penetration at a national level, “especially for those who can’t afford it,” said RSA’s Barriga.

And for those who can, the disaster has made them all too aware of the benefits of a comprehensive insurance policy including business interruption, which should have a positive impact on the insurance industry.

“The earthquake has made people see insurance as a necessary good and they will be more disposed to buy it,” said Barriga.

Chileans have started to rebuild but the ground beneath their feet could start to move again at anytime. When it does, the insurance industry will be there to cushion the fall.

Julian Dowling is the Editor of bUSiness CHILE

MAJOR EARTHQUAKES IN CHILE