For three decades now, I’ve heard insurance officials complain about disaster losses in the manner of fairy tale icon Goldilocks when she visited the home of the three proverbial bears. Carriers never seem to be comfortable with the level of catastrophe claims—either there are way too many or far too few.

This makes me wonder what level of cat losses would be “just right” for the industry’s bottom line, or even if there is such a magic number.

When insured losses from hurricanes, tornadoes, floods, earthquakes, etc., pile up over a short period of time, carriers understandably kvetch about the impact on their profit margins. Yet when such catastrophes are relatively few and far between, as they’ve been lately, you might think that would help insurance executives sleep soundly at night. In fact, during such “quiet” periods you start to hear concerns expressed about mounting overcapacity and the resulting downward pressure on pricing.

For example, there was recently some chatter in the media out of Bermuda about how some in the reinsurance industry think we could use a major catastrophe or two to scare off the new players who have flooded the business with capital over the past couple of years. Such a development, they believe, would restore their traction on pricing.

It’s true that, in this low interest rate environment, institutional and individual investors looking for better returns and uncorrelated risks to diversify their portfolios have been diverting some of their considerable capital into the property-catastrophe market. Hedge funds have launched reinsurance entities, believing they can beat the investment performance achieved by their traditional, usually more conservative, insurance industry competitors. Meanwhile, pension funds and individual investors are buying record numbers of catastrophe bonds, which at least for now offer better yields than many standard fixed income securities.

As a consequence, the market is awash in capacity, prompting reinsurers to either lower prices to remain competitive, or take a pass on more risks and let their market share decline. There is concern within the mainstream insurance industry that this trend will expand into casualty lines sooner rather than later.

The talk cited in Bermuda follows the logic that a major disaster loss or a series of catastrophic events may drive from the market what traditional carriers often dismiss as “naïve” capacity, while derailing new entities that may have underpriced their books of business. Established carriers would then be free to step up and fill the ensuing gap, while benefiting from higher prices for scarcer coverage.

This may be wishful thinking on the part of reinsurers eager to be rid of a new source of competition. In fact, I wouldn’t be surprised if some institutional and individual investors shared the same “Goldilocks” mentality with their more longstanding insurance colleagues. Sure, if there’s a catastrophe or two, some new, hedge-fund backed reinsurers might take a big hit, and the return on some cat bonds could vaporize overnight for a pocket of investors.

But just as the insurance market might “benefit” from a disaster or two in terms of drying up excess capacity and driving up prices, couldn’t these same factors also boost potential returns for alternative market investors? While some might indeed be discouraged and opt out, others may double-down or first enter the market to capitalize on rising prices.

Meanwhile, for all the “Goldilocks” insurers out there, the question remains as to exactly what is “just right” in terms of catastrophe losses. I don’t think there’s a firm answer. I tend to believe the property-catastrophe insurance industry (and any new players who join the fun) are destined to live in a market of extremes, in which underwriters must be prepared to sink or swim in any given year whether they face a flood of capacity in a quiet loss period or a flood of claims if a worst-case scenario disaster strikes.

If they are long-term players, profitability should balance out over time in such a cyclical market. That may be the ultimate advantage enjoyed by traditional carriers—being in it for the long haul, like a marriage, for better or worse.

In any case, the last thing I want to hear is talk about insurers lamenting the lack of disaster losses to stabilize prices and boost profits. For an industry that already has reputational challenges, such speculation comes across as pretty cold porridge indeed.

Sam J. Friedman (samfriedman@deloitte.com) is the research team leader at Deloitte’s Center for Financial Services in New York. These opinions are his own. For many years, he was the Editor in Chief of National Underwriter’s P&C edition. Follow Sam on Twitter at @SamOnInsurance, as well as on LinkedIn.

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Insurers are talking like &lsquo;Goldilocks&rsquo; about cat losses, and that's bad for the industry

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Insurers are talking like ‘Goldilocks’ about cat losses, and that's bad for the industry