Catastrophic Shocks in the Property-Liability Insurance Industry: Evidence on Regulatory and Contagion Effects

Abstract

Natural disasters are conjectured to have two opposing effects on insurance firm values: a negative effect due to payments on policyholders' claims and a positive effect due to expectations of higher premiums. We test for the presence and relative strengths of these two effects by examining the impact of Hurricane Andrew and a subsequent change in the regulatory environment on the stock prices of 48 publicly-traded property-liability insurers. We find that Andrew had a large negative effect on insurance stocks that was ameliorated to some extent by a smaller positive effect. This suggests that the market expected insurers to recoup some of their losses from Andrew with subsequent premium increases. We also find that Andrew and the regulatory event had industry-wide contagion effects since they significantly affected most insurers, regardless of whether these firms had any claims exposure in the hurricane-affected states.