After countless actions and strategies, the oil continues to flow into the Gulf of Mexico.  True, BP plc (BP) and its various partners slowed the leak and have been successful at collecting and processing some of the black gold, but tens of thousands of barrels a day continue to pour into the water.  What’s more, the situation could become further catastrophic, from an environmental, as well as a financial standpoint, if a tropical storm or a hurricane hits this area and deposits not just sea water, but oil onto shores and inhabited areas.

For example, Alex continues to pick up steam and experts, due to its wind speeds, recently classified it as this year’s first hurricane.  Thankfully, it appears that Alex will miss the spill area and travel west to Mexico.  Nevertheless, the storm has already caused oil cleanup efforts to cease in many spots.  Harsh winds and in some cases, 12-foot waves have  hampered collection activities, but this is a relatively small inconvenience when compared to what would probably transpire if a powerful tropical storm or hurricane hit the oil spill area directly.

Tropical storms and hurricanes bring high winds, large waves, and heavy rain.  These natural disasters typically threaten human life and lead to damage, and some in cases, total devastation to homes, businesses, and personal property.  On average, the Gulf experiences seven or eight major storms a year, of varying strength and resulting harm.  The oil spill, mixed with a powerful storm would create a unique event, as well as the possibility of a non-quantifiable amount of chaos and hardship due to Texas tea being dispersed onto beaches, streets, property, etc.  Clean up costs and property damage would be off the charts, with residents and business owners being placed in an untenable and dangerous situation.  It is safe to assume that Allstate Corp. (ALL), Progressive (PGR), and Berkshire Hathaway (BRKB), along with all other insurance companies with material operations in the Southeast, would also sustain immense catastrophe losses, possibly exceeding those incurred from Hurricane Katrina in 2005.

Katrina created quite a stir in regard to insurance.  A good percentage of people in Louisiana and the other areas affected, had hurricane insurance, but their houses and property sustained material damage from flooding, which insurance companies claimed was not covered by their policies (legal battles are ongoing to this day).  As for the possible problem at hand, it is safe to assume that residences and businesses in the Southeast do not possess oil spill insurance (no such product exists).  If such an event were to occur, it would probably create a similar contentious situation between customers and insurance providers over the difference between oil and hurricane damage, similar to what happened with flood versus storm devastation in the aftermath of Katrina.   Individuals, as well as the insurance corporations would probably turn around and seek compensation from BP and the other responsible parties.  Thus, massive legal action would ensue, which could lead to years or even decades of court proceedings.

The insurance companies, well aware of the consistent hurricane events in the Southeast, charge higher premiums to customers, when compared to residents of other regions in the United States.  Some years, due to mild hurricane seasons and low damage levels, these companies reap the benefits and post hefty profits.  However, during particularly active years, these corporations are forced to pay large claims which can lead to loads of red ink.  Insurance stocks typically follow the financial results, rising nicely during good times and falling when large catastrophe losses are realized.

A massive and growing oil spill, coupled with hurricane season creates the potential for a unique and possibly devastating event.  Insurance companies’ catastrophe losses could reach uncharted levels if a “perfect storm” were to occur.  In all, we recommend that investors with exposure to the insurance industry take note, and depending on their risk profile, investment strategy, and view of the situation, adjust their holdings accordingly.