JUNE 2006 E W I N G E T A L . 395 Insurer Stock Price Responses to Hurricane Floyd: An Event Study Analysis Using Storm Characteristics BRADLEY T. EWING Jerry S. Rawls College of Business, and Wind Science and Engineering Research Center, Texas Tech University, Lubbock, Texas SCOTT E. HEIN Jerry S. Rawls College of Business, Texas Tech University, Lubbock, Texas JAMIE BROWN KRUSE Natural Hazards Mitigation Research Center, East Carolina University, Greenville, North Carolina (Manuscript received 20 January 2005, in final form 30 September 2005) ABSTRACT This research uses an event study methodology to examine the effect of Hurricane Floyd and the associated scientific and media releases on the market value of insurance firms. The research is unique in that information describing the development of the storm over time and space is incorporated to determine how the financial market reacted to changing news about a storm’s characteristics. Key empirical results can be summarized as follows. Overall, there was a negative effect on insurer stock price changes around the synoptic life cycle of the storm; however, this effect was neither constant nor was it always negative on each day of the cycle. Significant market reaction to the news concerning the path and strength of the storm prior to the storm landfall was found. The results herein suggest that markets find reliable time-sensitive reports provided by the National Weather Service, the National Hurricane Center, and other media outlets to be valuable information. 1. Introduction tops the list (the 11 September terrorist attack ranks second). Given the large amount of physical and eco- In September 1999 Hurricane Floyd hit the area nomic damage it should not be surprising that insurance around Wilmington/New Hanover County, North firms were materially affected by these windstorms. Carolina. Swiss Re ranks Floyd 23rd on its list of the 40 What is not so clear is exactly how and to what extent most costly insurance losses worldwide from 1970 the value of insurance firms would respond to the ex- through 2004. (The ranking uses property and business pected damage. The accuracy of and public access to interruption losses, excluding life and liability losses information concerning the expected magnitude of a and can be found online at http://www.swissre.com.) tropical system has expanded significantly over the 10 Insured property and business interruption losses of yr since Hurricane Andrew. Because the severity of a $2.548 billion (indexed in 2002 dollars) were attributed hurricane develops and evolves over both time and to Floyd. Although Floyd was devastating to millions of space, dating this type of event by date of landfall alone people, it ranks far below Hurricane Andrew, which is likely to give an incomplete description of the market moved across Florida south of Miami in August 1992. response. With $20.511 billion of insured property and business It is expected that the development of potentially interruption losses (indexed in 2002 dollars), Andrew catastrophic events plays an important role in deter- mining the value of firms in the insurance industry. As such, this study seeks to determine how the stock prices Corresponding author address: Dr. Jamie Brown Kruse, Center for Natural Hazards Research, East Carolina University, Brew- of insurance firms behaved before, during, and imme- ster A-438, Greenville, NC 27858. diately after Hurricane Floyd because financial market E-mail: [email protected] participants would take accurate and readily available © 2006 American Meteorological Society Unauthenticated | Downloaded 09/29/21 04:12 AM UTC WAF917 396 WEATHER AND FORECASTING VOLUME 21 spatial and atmospheric characteristics of the storm into earlier studies. In contrast, this study examines market account. We also perform a comparison study analyzing reactions produced by Hurricane Floyd on the insur- the response of insurer stock prices to 1992’s Hurricane ance industry prior to hurricane landfall, taking into Andrew. account the actual development of the storm over time Economic research aimed at measuring the effect of and space. It is logical to expect that market analysts do an event on the value of firms and businesses is typi- not wait for all uncertainty to be resolved, but rather cally conducted in the event study framework. It has use all information as it becomes available to update become common in finance to measure an event’s eco- and refine their estimates of the financial impact of a nomic impact by using asset prices observed over a rela- hurricane. We conduct an event study that utilizes the tively short time period (Campbell et al. 1997). This synoptic life cycle of a hurricane as the event “date” methodology utilizes financial market data to estimate and describe the responses of insurance stock returns in the equilibrium or “normal” return for a stock price or light of storm characteristic information. In other index over a window of time (via a standard time series words, we see a multitude of different events that cor- model), and then isolate the effect of the event by con- respond with the release of information by the National trolling for when the event occurred. A normal return Hurricane Center (NHC) and National Weather Ser- for an industry is seen as capturing all quantifiable risk vice (NWS). Although investors may use a broad vari- in the value of the stock. In other words, the stock price ety of available information sources, including media takes into consideration the value of future insurance reports and expert opinion, we use the measurements premiums and payouts based on the first and second provided by the NHC because it is relatively unbiased, moments of the net income distribution. The first mo- publicly available, and considered credible. Johnson ment captures the statistical expectation. The second and Holt (1997) note that, generally speaking, weather moment captures the variance and therefore the re- data and forecasts are “public goods” that generate sig- maining risk, given the risk management strategies in nificant positive externalities in the economic sense. place for typical firms in the industry. Abnormal per- The input of meteorological and atmospheric param- formance is indicated by returns that are statistical out- eters such as pressure, wind speed, storm direction, and liers to the distribution, in other words, an event with location associated with the hurricane event can be very unexpected magnitude. Thus, normal performance may important information to financial markets and are be compared to abnormal performance that is, presum- used to construct the windstorm characteristics. Hurri- ably, driven by the event (Campbell et al. 1997). Using cane track and intensity as provided by the NHC were event study methodology, research has shown that the used to characterize the evolution of the hurricane market value of insurance firms is significantly affected event. This unique feature of our research provides a by catastrophic events, such as a hurricane. Lamb significant improvement over the standard event study (1998) found evidence that in 1992 when Hurricane An- analysis. To date, no other study has focused on the drew hit south Florida and Louisiana, property and ca- characteristics of a windstorm when analyzing or ex- sualty firms with exposures in these areas saw their plaining the market responses of insurer stock prices. stock returns adversely affected. This is not surprising The ability of an unfettered trading institution to given the amount of destruction these natural hazards quickly assimilate relevant information is summarized cause and the corresponding insured losses. Still others by the efficient markets hypothesis that states all rel- have argued that a natural disaster may have two op- evant and available information is incorporated into posing effects on the value of insurer stock prices current financial asset prices (Campbell et al. 1997). (Angbazo and Narayanan 1996)—a negative effect is The efficient markets hypothesis is one of the most hypothesized because of payments on claims and a influential and fundamental theories in finance. It sim- positive effect may be because of expectations of higher ply states that financial market prices should reflect all future premiums. available information. In particular, this means that MacKinlay (1997, p. 37) has stated in his review of market prices should reflect expectations of relevant “event studies in economics and finance” that “An im- events. For example, if market participants are con- portant characteristic of a successful event study is the vinced that a firm is going to increase its dividend, this ability to identify precisely the date of the event.” How- will already be priced in the stock price and the stock ever, previous research has not specifically considered price will not change with the news of a dividend in- the storm’s characteristics as the storm evolves over crease. Roll (1984), for example, provides evidence time, but instead the focus has been centered on the showing that financial markets, in the case of prices for date that the hurricane made landfall. That is, the date orange juice futures contracts, are very much linked to that a hurricane makes landfall has defined the event in weather forecasts, especially predictions of freezing Unauthenticated | Downloaded 09/29/21 04:12 AM UTC JUNE 2006 E W I N G E T A L . 397 weather, provided by the NWS. In a similar vein, this TABLE 1. Summary of descriptions of Hurricane Floyd. (Source: paper investigates whether the financial markets re- NHC) sponded to hurricane-track and intensity information as Synoptic life cycle 7–17 Sep 1999 provided by the NHC therefore indicating its value. Estimate of total U.S. damage $3–$6ϩ billion Number of deaths in United States 56 2. Background and related research Maximum wind speed (Saffir–Simpson 135 kt (category 4/5) The direct losses from hurricanes can total in the scale category) millions, even billions, of dollars (West and Lenze Wind speed at landfall 90 kt Saffir–Simpson scale category at landfall Category 2 1994).