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What Impact Do Natural Disasters Have On My Investment Plan?

2020 seems to have brought on an especially heavy dose of hurricanes, tornadoes, earthquakes and fires. How do natural disasters impact us as investors? Jared Kizer explains.

Transcript

Tim Maurer:

Hello, Tim Maurer, back with another episode of Ask Buckingham, a video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Jared Kizer, Chief Investment Officer of Buckingham Wealth Partners. Jared, today, I’d like to talk about something that is on all of our minds and that is natural disasters. Regardless of the year, we always end up dealing with something. Hurricanes, tornadoes, earthquakes or fires and it just feels like this year in particular, we’re getting an especially heavy dose. I’m curious, from your perspective as an investor, how do they impact us? How do natural disasters impact us as investors?

Jared Kizer:

In general, I’d say broadly, they tend not to have a big impact directly on markets or at least diversified portfolios. Now, of course, we can always question whether that would continue to be true as we go forward from here with climate change and other factors and what’s possible on the national disaster front, but like a lot of things, we’ve got a long period of history to look at here, a lot of bad things that have happened going back in time and generally, even those things that would be certainly devastating for people in those areas, companies in those areas, when you look broadly, historically, they’ve not tended to have a big impact on financial markets. Even if you picked out some of the worst events historically across those categories that you’ve talked about, that again, have certainly had major disruptions in certain regions, have tended to not impact markets broadly, in most cases.

Tim Maurer:

Well Jared, what type of companies typically are most impacted by natural disasters?

Jared Kizer:

First and foremost it would be certainly any company that has major operations in the area that’s impacted. You think about say, a typhoon hitting Japan or Tokyo, obviously that can be disruptive for companies that are in that area or the wildfires that we’re seeing out west, certainly, companies that have a bases in those and depending upon what they do, can be very significantly impacted by those events. First thing, I definitely would revert right back to the folks in companies that are located directly in those areas. Of course, when you think about public financial markets, most every company is to some degree global at this point, in terms of their operations, their sources of revenues, so that’s one of the reasons that you see at the global market level or even the national market level tends not to have a big impact.

Jared Kizer:

When you step one level down from there the next thing you come to is certainly natural disasters, at least in the developed world. Unfortunately, in a lot of the emerging markets are developed economies, but in the developed world, we’re fortunate to have a pretty robust insurance industry. Certainly those companies are going to be impacted by most natural disasters, earthquakes, fires, hurricanes, typhoons, in developed economies are certainly going to impact those companies. Now, of course, what those companies are trying to do over time is to make sure they’re calibrating that risk as finely as they can and trying to price their insurance coverage so that even net of those events over time, that they’re still able to make a profit. Insurance companies, even though they’re operating in a very dynamic world at this point on this particular front, over time, they seem to have done a good job of being able to price those risks appropriately, over time, to be able to be there to provide the insurance coverage, but also to be able to be there long term as profitable of companies that certainly in the insurance industry is the one most squarely impacted here, once you move beyond the companies that are in those particular areas.

Tim Maurer:

Wait, so Jared, am I hearing you correctly that insurance companies are generally profitable?

Jared Kizer:

They are. I know that’s going to shock everybody that’s listening to this Ask Buckingham. Not the most beloved industry that we have, but certainly we see over time they seem to be very good at pricing risk and as a result over time have tended to be profitable as an industry. Of course it can be different for any particular insurance company, but as an industry, absolutely. You’ve certainly seen that over time.

Tim Maurer:

Yeah. Well, let’s talk about this a little bit more specifically. I guess the point here is that just because a natural disaster occurs, doesn’t necessarily mean that an insurance company is going to lose money on that if they have properly gauged the risk associated with these disasters, is that right?

Jared Kizer:

That is right. If you look at where we stand at this point, at the time that we’re recording this, in late September, even though there have been a lot of bad things that had happened on the natural disaster front, particularly as we’ve seen again out west in Oregon, California, other areas, as it stands right now, I know this would probably shock a lot of people, but the insurance and reinsurance industries, broadly, are probably still net profitable year to date. Partially that comes from, and I know we’re getting into some details here, partially that comes from, certainly it’s been a tough last couple of years on the natural disaster front. After those years transpired, you’ll tend to naturally see insurance companies will start then the next year. They’ll be charging higher premiums, higher insurance premiums than they were the year before, which can make their results as companies robust and even on years that are as difficult as one that we’re seeing like 2020.

Tim Maurer:

Sure. In addition to that, insurance companies also have insurance of their own, on their insurance. Is that right? What would we call that and how does that work?

Jared Kizer:

It is, to make things just a little bit more complicated. That would be reinsurance. Thankfully you can summarize it pretty succinctly, so it’s insurance for insurance companies. It’s the next layer in the ecosystem that we’re talking about here. The example that I like to use and I think it clicks for most folks is when you think about State Farm, a name that we all know, while obviously highly involved in the US insurance market. If you think through it, you could say, well, they could certainly get to a point where they’ve gotten more exposure to say real estate in Florida than they would otherwise like to. Meaning they’re getting a lot of demand to write policies, insurance policies, on things that are located in Florida. Because they are good at managing risk, they’ll certainly get to a point where they say we want to write these policies, we don’t want to turn clients away, but we also know we’re accumulating probably more risks specific to Florida than we need to, which obviously could be impacted by hurricanes and potentially other events.

Jared Kizer:

The way this world has developed over time is that they would then look for a reinsurance company to essentially share in some of the risks of the policies that they’ve underwritten in Florida. These reinsurance companies are not going to be nearly as well-known because there aren’t that many and the names are just not as well known here in the U.S. as some of the U.S. based insurance companies, yet it’s a big vibrant market and helps insurance companies better manage the risks of the policies that they underwrite and allows them not to have to turn away business. Basically allows them to continue to service clients, but also manage their businesses appropriately from a risk perspective.

Tim Maurer:

That whole process almost demonstrates an opportunity perhaps for investors in this insurance and re-insurance space. Could you mention any particularly famous investors or types of investments that people could consider in order to take part in these profits?

Jared Kizer:

Yeah. On the first count, certainly Buffett comes to mind. Anybody that’s spent any time studying Buffett knows that he’s been heavily involved in the reinsurance. Businesses have known that’s been a profitable business over time and one of the more, probably the most well-known firm, certainly in the reinsurance business. A lot of the other names that I could mention, like a Swiss Re. Some folks may have heard that, but a lot of folks are not going to even know who that is, but Berkshire certainly comes to mind there. Then yeah, on the investible market side, it has been a growing portion of the world’s investible markets because, particularly when this first started, institutional investors thinking endowments, foundations, public pension plans. If you think through, from an investment point of view, a lot of what we’ve talked about today, you quickly understand that, well, over time, this has been a profitable business, reinsurance, insurance, but also a business that’s not highly related to what the stock market is. There’s a diversification opportunity here.

Jared Kizer:

There has been a significant interest from the investible markets to try to find ways to participate in the reinsurance business directly because of those dynamics. Certainly you’ve seen, even now down to the individual investor level, where it is possible to get exposure to the risks and returns of the reinsurance marketplace, something that was not possible say 15, 20-years ago.

Tim Maurer:

Am I hearing you correctly then that, whereas most of the investments that we put money into are kind of market oriented. Whether they’re the stock market or the bond market, they have a connection, the two of those asset classes and so by introducing something like reinsurance, that is not going to be impacted as much by market factors, it’s going to be impacted more by weather and events that take place. That can add a layer of diversification in our portfolio?

Jared Kizer:

Yeah, absolutely. When you think about virtually every person that I talk to that invests, without a doubt, long-term, the biggest risk that you’re taking, essentially stock market risk. Even if you got a relatively low allocation of stocks. Stocks are just so volatile, even held in diversified fashion, that it drives the ship from an investment perspective. Yeah, you certainly want to think about what other things can I do that I expect to add, to be able to generate some return over time, but compliment, offset, some of the risks that I have in the stock portion of the portfolio and certainly there are lots of things that fit there. Reinsurance would certainly be one of those for the reasons that we talked about on the the top end of the question, in terms of, yeah, there’s risks there, but it’s risk that tends to be unrelated to what the stock market is doing or influencing what the stock market does.

Tim Maurer:

Jared, we start to run into a little bit of a human challenge processing all of this intellectually, don’t we? We look at a year like 2020 and so many are feeling the burden of so much pain. Whether we’re talking about the pandemic. Whether we’re talking about issues of social justice. Whether we’re talking about hurricanes, just multiple, one after the other, plowing right into the Gulf coast or the incredible fires that are taking place on the west coast. It has a tendency to make the market feel pretty darn heartless. How is it that the market is doing well in the midst of so much pain? Can you help us reconcile that?

Jared Kizer:

Yeah, it’s a good question and another example of just how unpredictable markets can be. I think if you just try to put yourself back to January of 2020 and you were told everything that you just relayed, with a lot of detail, I think almost everybody, including me who does this 24/7, would have predicted that sounds like that’s going to be a very, very difficult year for stock markets. It is, one, I completely understand where that question comes from, completely understandable. I think the first thing that I would point to here is the just massive amount of intervention from central banks and federal governments globally back in February, March, April, May and of course, continuing on to now. I certainly think they have backstopped the markets to some degree, prevented and I know certainly folks with lots of different perspectives on what should and shouldn’t be done, but I think it’s fair to say that back in March, there was certainly some meaningful possibility that there was going to be a lot of disruption, particularly in credit markets and fixed income markets and the ability for companies to continue to borrow. You saw governments, central banks, intervene.

Jared Kizer:

First and foremost, probably first, second and third that’s what I would point to in terms of how would you explain where stock markets are at given everything that you’ve mentioned there is the level of intervention, that you’ve seen. The second thing I would point to is that, I know, unfortunately, this has not benefited everybody in the same ways, but a lot of folks are thankful to be able to be in positions where they can utilize technology like we’re doing today, to be able to continue to do roughly what they were doing before. I think that the pandemic, especially happening in 2020, relative to have this happen in 1935, to pick a random year, would have been a completely different animal from an economic perspective because obviously there’s a lot of the technologies that have helped, at least a large fraction of folks, didn’t exist back then. There would have been much broader, I think, macro-economic implications if that can… If you can even process this because obviously the applications have been huge in 2020, but we’ve at least, again, silver lining, had a lot of folks that have basically been able to continue to do what they were doing before.

Jared Kizer:

Those two things, the big amount of intervention that we’ve seen from central government, central banks and then secondarily, even though it hasn’t helped everybody evenly, unfortunately, the fact that we have had the technology for a lot of folks to be able to continue to operate as best they can, as they were before, just in more of a remote environment. Other factors, but those, I think, are the top two that help you to reconcile what we’ve seen from markets compared to where things were headed back in February and in March.

Tim Maurer:

Very insightful. In a bigger picture level, Jared, I tend to think of the market… It’s almost an inherently optimistic creature, right? We look back over history and even in some of the most painful times, despite those events, the market has prevailed in the long-term and in many cases it may even be especially because of those events because they create a certain wave of reinvention throughout the country and throughout the world. New opportunities that are posed for the future. I’m going to stick with that optimistic view if it’s okay with you.

Jared Kizer:

Sounds good.

Tim Maurer:

Well, thank you so much Jared and thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com or by emailing your question to question@askbuckingham.com or just click in the upper right corner of the screen, it’ll take you directly to the website. Remember that there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, it will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision-making. Please follow us and by all means Ask Buckingham.

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