The Biggest (And Least Well-Known) Investment Trend of 2006

If I asked you to name the biggest investment trends of the next 12 months, the following might come to mind:

Energy. 
Gold. 
The end of the housing bubble. 
China. 
India. 
Japan’s turnaround.

But I’m willing to bet that property catastrophe reinsurance not only wouldn’t be on your list...odds are you’ve never even heard of it before!

Property catastrophe reinsurance is insurance for insurance companies. It protects them against huge losses caused by manmade and natural disasters—like 9/11... or Hurricane Katrina.

Hurricane Katrina is the largest insured loss in history. The federal government has already approved more aid for Katrina than for 9/11, Hurricane Andrew and 2004 Hurricanes Charley, Frances, Ivan and Jeanne combined.

When a huge insurance loss like Katrina happens, it’s like a “perfect storm” for insurance pricing. The devastating losses are so large that they shrink the amount of reinsurance capital available. Katrina will shrink the reinsurance industry’s capital by more than 20%.

Imagine waking up and realizing you suddenly have 20% less equity in your house: very big deal. If you wanted to borrow against that equity, you suddenly have less available to borrow (and the bank might just charge you more for it, too).

Same thing with reinsurance. With much less capital on hand, the supply of insurance underwriting capacity falls. All of a sudden, there’s less insurance available for sale.

At the very same time, everybody realizes that the computer models the reinsurance industry relied upon didn’t do an adequate job, so the industry has to charge more for taking on the same amount of risk. AND—insurance companies are scared another big event might come along, so they generally want to buy more reinsurance coverage than before, not less.

So, demand shoots up.

From this point, it’s Economics 101: when the supply falls dramatically and the demand rises sharply, there’s only one thing that can happen: Higher prices.

Everywhere I look in the insurance and reinsurance industries, everyone is hunkering down for higher reinsurance prices in 2006...

Dan Hale is the CFO of Allstate (NYSE:ALL), one of the biggest insurance companies in the country. Hale remarked at an insurance conference in New York last week that, “The cost of reinsurance will definitely increase... there is no doubt there will be an increase.” CFOs from AIG, Inc. (NYSE:AIG) and Bermuda-based Arch Capital Group (NYSE:ARH-B.CL) agreed with Hale.

I asked the only Wall Street insurance analyst I trust if he thought insurance premiums would increase after Katrina. He usually gets back to me in an hour or two. This time, it took him two days, and his reply was that of an excited and busy man: “It will be a very hard reinsurance market, with rates up 40% for accounts that have had losses.”

I then forwarded that response to Jim Bryce, CEO of IPC Holdings (another property catastrophe specialist) and he shot back an unequivocal reply: “I concur!”

As you know, True Wealth editor Steve Sjuggerud likes investments that are hated, and on the rise. That’s where reinsurance companies are right now.

They’re hated because most people think the business is too complicated to gain a good understanding of it. They’re on the rise because some smart investors know what happened after Hurricane Andrew in 1992 and 9/11 in 2001. Both events set off major bull markets in reinsurance prices. Katrina will too.

I’ve recommended three reinsurance companies and two other reinsurance-related companies in the pages of my newsletter Extreme Value. I’ve publicly disclosed my recommendation of PXRE Group (NYSE: PXT).

PXRE is the oldest property catastrophe specialist in existence. It’s also one of about ten companies worldwide that provide retrocessional coverage (reinsurance for reinsurers).

PXRE will see price increases in its main lines of business between 35% and 100% in 2006 - which could drive a big increase in share price. For instance: after the 9/11 tragedy, this stock ran up over 100% in under 9 months.

It’s not as exciting as a junior gold stock... and it’s not getting headlines like China does. But reinsurance is my pick for the #1 investment of 2006.

Good Investing,

Dan Ferris