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Tickers in this Article: PRE, XL, ACGL, ACE, WRB, RIG, CAM, MRH
Cleaning up the mess left in the wake of the explosion and sinking of the Deepwater Horizon is going to be a multi-part process. BP is doing its part, trying to stop the shattered well from dumping even more oil into the Gulf and cleaning up what has already come out. Looking ahead, though, there will also be a major role for the insurance industry to play, as it is often insurance companies that bear the brunt of the financial ramifications of accidents like Deepwater Horizon.

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Cost Estimates Are Starting To Come Ashore
All told, the most common estimates floating out there for total insurance industry exposure to the Deepwater Horizon event range from about $1.5 billion to $3.5 billion. Should the bulk of the spill stay at sea, the losses will probably be on the lower end of the range. Should the oil come ashore in large quantities, though, it is likely that various business interruption policies will be triggered, pushing up the costs to the industry.

So far, a host of companies have come forward with their initial assessments of liability. For the European players, the amounts range from $200 million at Swiss Re to $60 million at Munich Re to $53 million for Hannover Re. Among insurance companies with listed shares in America, PartnerRe (NYSE:PRE) has estimated a loss of $65 million, XL Capital (NYSE:XL) a loss of $30 million, Everest Re a loss of $20 million, Montpelier Re (NYSE:MRH) a loss of $20 million, and less than $20 million for Transatlantic Holdings, Arch Capital (Nasdaq:ACGL) and Platinum Underwriters.

In addition, my research suggests that other insurers like ACE Limited (NYSE:ACE), Flagstone Reinsurance and WR Berkley (NYSE:WRB) could have some level of exposure to the accident as well, generally from reinsurance exposure to BP.

The Industry Will Adapt as it Always Does
As a one-off incident, the Deepwater Horizon accident is not a devastating one for the insurance industry. This is due in part to the size of the accident (relatively small compared to earthquakes or hurricanes), but also to the widespread diversification of the loss and the fact that BP largely self-insured its risks. None of the losses from that initial list of exposure estimates are exceptionally large and there are many names on the list. Even assuming that these estimates prove low, the ramifications of this accident seems like it will not be too serious for the industry. (For related reading, check out When Things Go Awry, Insurers Get Reinsured.)

In a wider context, though, this is another hit to the industry that has recently seen a serious earthquake in Chile, a bad storm in Europe and Australia, and meaningful losses over the winter in the United States. Going into this event, the market was soft - that is, there was a surplus of capital looking to underwrite insurance, so premiums were weak. Although this single incident will not likely flip conditions to a hard market (i.e. higher premiums), the overall trend of losses seems to be pushing in that direction.

What Happens Now?
Underwriters are likely going to reexamine some of their basic assumptions about the industry and rates for marine insurance are going higher. Longer term, expect tighter safety, inspection and redundancy requirements in offshore drilling. This is likely to come no matter what the U.S. government ultimately says or does about the accident - the simple reality is that companies are more afraid of their insurance underwriters (and what they will or will not pay for) than of governments.

This, in turn, will likely mean higher costs for drillers like Transocean (NYSE:RIG) and Noble, operators like BP, and equipment and service providers like Halliburton and Cameron (NYSE:CAM), particularly if faulty equipment or procedures are seen as the ultimate cause.

The Bottom Line

For the insurance industry, this is just part of the cost of doing business, and I am not sure this is an "investable event". Still, some insurers like Arch Capital, ACE, and WR Berkley are exceptional companies and somewhat undervalued stocks. Though there are definitely some risks buying insurers in a soft market (with hurricane season on the way), that soft market may soon be changing and that would mean positive things for earnings in the sector.

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