NEW YORK (CNN/Money) -
Investors are shying away from shares of insurance companies amid predictions that Hurricane Katrina's path of devastation could cost the industry between $12 and $25 billion.
Insurers such as Allstate (Research), St. Paul Travelers (Research), and Hartford Financial Services Group (Research) -- which have particular exposure to the hurricane-prone Southeast region of the U.S. -- are getting hit. And analysts are keeping a close eye on reinsurers -- the insurers of the insurance industry that will ultimately bear the most burden of the hurricane damage. Reinsurance stocks such as RenaissanceRe (Research) and XL Capital (Research) were under water Monday.
"When you look at any catastrophic event, it's a knee-jerk reaction to sell these stocks," said Michael Paisan, principle at Legg Mason Wood Walker.
He added that once the initial selling subsides, investors traditionally plow back into insurance stocks in anticipation of rate increases down the road. For savvy investors, the current weakness in the insurance market could be seen as a buying opportunity, he said.
Stocks have already bounced off their lows of the session with American International Group (Research) turning into positive territory and Alfa Corp. (Research) -- which has the largest exposure to the Alabama homeowner's insurance market -- up almost 6 percent . Analysts said stocks may be betting for a spike in rates but warned that it's a scenario that may be too early to call.
"I'm surprised at the speed with which the market has gone up," said Paul Newsome, equity analyst at A.G. Edwards. "It's premature and my guess is that rates aren't going to go higher."
He added that for rates to warrant any significant increase, the insurance industry would have to demonstrate a poor pricing environment and the industry would have to face a catastrophic event that resulted in damages that were beyond the current realm of the imagination, such as the World Trade Center attacks or the unprecedented damage that came in the wake of Hurricane Andrew in 1992.
Forecasters may be calling for an increasingly severe hurricane season, but the insurance industry is better prepared this time around, analysts said, and that could put a cap on how high rates can go.
So if rates aren't poised to go much higher, should investors avoid the insurance industry?
Analysts advised caution but said there's plenty of opportunity, as long as investors aren't betting on rates.
With almost $400 billion in industrywide capital, "the insurance industry as a whole will emerge in a healthy financial state," said Donald Light, senior analyst at Celent.
Analysts are expecting Hurricane Katrina to drive weakness into third quarter earnings reports for companies such as Allstate, St. Paul Travelers and AIG, but for investors looking for a long-term investment, the general outlook on the industry remains bright.
A.G. Edwards' Newsome said St. Paul Travelers, in particular, is currently trading at an attractive valuation with room for upside as the company continues to turn around its business after struggling with post-merger integration issues.
But investors should tread lightly when it comes to reinsurance stocks such as RenaissanceRe. In a research note, Merrill Lynch analyst Jay Cohen said "one very sizeable storm like Katrina would be worse for reinsurers than four separate big storms " because reinsurers will be forced to take on a higher level of risk at one time.
Legg Mason Wood Walker's Paisan said the reinsurance industry will likely attempt to recoup some of its losses by raising rates for insurers down the road and may attempt to demand that regulators and insurance commissioners for Louisiana and Mississippi create state reinsurance-like entities, similar to Florida's hurricane catastrophe fund, to help spread the risk.
Newsome said that investors may want to stock up on a reinsurer like ACE (Research), which is currently cheap in comparison to its peers, but analysts warned that investors should remain cautious when looking at reinsurers as an investment opportunity.
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