Follow the Money
England’s 1603 Insurance Act declares: “The loss lighteth rather easily upon many, than heavily upon few.” In this tradition, claims from even the most damaging storms are divided and distributed around the world, to be spread over many pools of capital. Still, the recent spate of tempests will truly test the efficacy of a system in which major losses are shared among the many.
In fact, Hurricanes Harvey, Irma and Maria are the first truly major storms to test the global risk transfer market in a dozen years.
For a global market that has been cutting prices for a decade, with competition so fierce that rates overall have been cut to (or even into) the bone, the catastrophes of the third quarter are seen by insurers as both good and bad. According to A.M. Best, some international risk carriers were not covering their cost of capital even before the storms lashed their P&L accounts. That means the 2017 Atlantic hurricane season will erode the industry’s enormous capital base. However, it may also drive a longed-for rise in market pricing, potentially reversing its fortunes.
The trio of hurricanes spread their damage widely and generously across the major lines of insurance business. Homeowners, auto and small commercial risks were obviously hit hard. Flood-proof retailers will claim business interruption losses if the area they serve was evacuated of customers. Travel insurers may indemnify throngs of Florida vacationers who never made it to the beaches of the Sunshine State. Yacht and energy insurers will be buffeted. Those with multiline exposures in the Caribbean, Texas and Florida—especially multistate carriers, E&S insurers and international reinsurers—have been stung particularly badly.
Harvey is manageable. Wayward Irma caused most to sigh with relief. And Maria remains a frightening unknown quantity, although it appears less severe than some early estimates. Together, though, the storms have dealt a painful blow to almost every international player.
Florida is one of the windy threesome’s badly battered victims, but it could have been worse. With a slightly different track, Irma would have wiped out Miami and created a projected $131 billion loss, according to a Lloyd’s “realistic disaster scenario.” A.M. Best put insured value in the state at a massive $2.2 trillion. Florida-based insurers cover about three quarters of the exposure. State subsidiaries of national carriers carry $250 billion, and $111 billion is on the books of state-run Citizens Property Insurance. Above them, sharing the risk of catastrophic losses, are a variety of conventional and alternative capital reinsurers. Irma’s impact is big for many of them though well below worst-case scenarios, but Irma did not act alone. Add two more land-falling hurricanes, a pair of devastating Mexican earthquakes and October’s voracious inferno in California, and the sting of events begins to look much more serious.
Analysts at investment bank Morgan Stanley described the third quarter of 2017 as potentially the worst insured natural catastrophe experience on record for the period. If catastrophe modelers’ top-end estimates—which reach $35 billion for Harvey, $50 billion for Irma, $85 billion for Maria, up to $5 million for the earthquakes and $8 billion for the fires—translate to actual indemnities, the total will indeed be record-breaking.
It would come perilously close to the magical $200 billion threshold market pundits have been saying would be required to drive prices rocketing upward and create a new “hard market.” At $150 billion, the global reinsurance sector’s entire premium income for the year would be wiped out.
Already signs of rising prices have emerged, although with claims still being filed and damages being assessed, it is too soon to gauge the final impact. It seems impossible, however, that any broker will manage to negotiate what has come to be the expected annual discount at the next renewal for any major risk, and it’s likely that their customers will face at least a modest increase.
Round She Goes
Individual companies’ losses are difficult to nail down with certainty, even internally. Giant Munich Re revealed it expects to miss its 2017 profit target of $2.3 billion to $2.8 billion after taking a $3.1 billion hit from the storms, although it did not specify likely losses from specific catastrophes. It may collect some indemnity through its “Eden” sidecar facilities, which provide proportional retrocession (reinsurance for reinsurers), and its “Queen Street Re” cat bond, which has parametric triggers and covers some United States hurricanes. Both are funded by capital markets investors rather than Munich Re shareholders.
One big hit will come from Maria-mashed Puerto Rico, where Munich Re has a 13.7% market share, according to analysis from Keefe, Bruyette & Woods. It has by far the largest market exposure to the island of any single carrier—HDI is next with 7%—and is almost certain to deliver Munich Re a multibillion-dollar gross loss, even if actual Puerto Rican losses fall at the lowest end of modelers’ forecasts.
Swiss Re, the world’s second-largest reinsurer, predicts an even more eye-watering $3.4 billion net loss. Other major international reinsurers will also be bludgeoned. Warren Buffett’s reinsurance giant Berkshire Hathaway (which owns a strategic slice of Swiss Re) had not revealed a number at press time but at least will see a massive hit from QBE, the Australian international insurance group. QBE will reportedly burn through a $900 million aggregate reinsurance program provided by Berkshire Hathaway, which suggests QBE faces gross claims in excess of $2 billion, including from non-hurricane catastrophes.
Even before the storms, ratings agency S&P had placed Berkshire’s AA+ insurance rating on negative outlook, which affects subsidiaries including National Indemnity, General Re and Geico.
The reinsurance market is awash with excess capital after years of only minor catastrophe experiences and a veritable flood of investment into the business through alternative routes like catastrophe bonds and collateralized reinsurance by pension funds and others, but at least some of that excess has now been blown or washed out.
Analysts at J.P. Morgan have reportedly calculated that the majority of reinsurers will see their full-year profits fall by at least 80% as a result of the storms. Ratings agency Fitch said the losses will erode some insurers’ and reinsurers’ capital base, which seems a certainty. Morgan Stanley said the losses are likely to halt reinsurers’ share buy-backs, although Munich Re said it will continue purchasing its own shares at least until the end of the year.
Lloyd’s—a market, not a company—said its carriers may face net claims, after reinsurance, of $3.9 billion for Harvey and Irma, down from an earlier forecast of $4.5 billion. It has made a preliminary forecast for Maria of $900 million. Keefe, Bruyette & Woods says the market in aggregate has an 8% market share in devastated Puerto Rico.
Much of Lloyd’s overseas business is underwritten through “delegated authority,” a system that allows local and regional underwriters to issue Lloyd’s policies according to relatively strict standards. Other exposures are through Lloyd’s per-risk, or “facultative,” reinsurance, a wholesale product whereby an insurer purchases cover for large losses to an individual risk.
Most of Lloyd’s exposures will be further reinsured in some way by international markets, and it is beginning to become clear which Lloyd’s players will bear the brunt of that pain. Much of Lloyd’s primary insurance loss in the U.S. will arise from its excess and surplus lines underwriting. The market is dominated by Lloyd’s and AIG, which together held more than 31% of this profitable, multifaceted market in 2016, yielding combined direct written premiums of more than $13 billion, according to A.M. Best. Together, Lloyd’s and AIG may face claims of up to $7 billion. Market sources say E&S prices for catastrophe-exposed risks are already starting to rise by as much as 30%.
More than half the losses caused by this year’s unprecedented string of natural catastrophes are uninsured. In many cases, taxpayers and international aid will pick up part of the tab. To decrease this burden, many governments have become much more proactive, taking steps to ensure at least some loss funding is in place before catastrophes occur, whether through state-backed insurance plans, government insurance buying or other structures that aim to ease the costs of relief and reconstruction.
The dynamics of Florida’s homeowners insurance market have changed significantly over the 25 years since Hurricane Andrew battered Miami-Dade County. National insurers and many international reinsurers drew back their coverage. Citizens was created under state legislation in 2002 to provide competitively priced cover for consumers who were seeing insurance prices shoot upward, and the Florida Hurricane Catastrophe Fund (FHCF), another state-backed body, was launched to provide reinsurance to all carriers with homeowners wind exposure.
Citizens has released an initial estimate of Irma losses of $1.23 billion from 70,000 claims but has “ample resources to pay claims,” according to a company statement. If its estimate is correct, Citizens will retain a surplus of $6.4 billion after collecting $193 million in reinsurance from the FHCF. However, had Irma held to its original course, the story would be much different.
Some of Citizens’ losses are ceded. It is required to purchase reinsurance for 100-year events. Its disclosures show it has various reinsurance protections in the private market, alongside Everglades Re, a capital-markets catastrophe bond. Together they protect Citizens’ various risk portfolios with more than $3.6 billion of cover, but currently only the FHCF reinsurance is expected to be drawn down. A cautious approach and a lack of major events for many years has allowed Citizens to accumulate very healthy reserves.
Florida’s hurricane reinsurance facility covers 159 Florida insurers for hurricane wind losses, although it does not reinsure storm surge. Buying FHCF reinsurance for a fixed share of Florida homeowners premium income is mandatory for insurers with exposures there, although the level and structure of the cover purchased is flexible. Under statute, it pays claims when industry losses from a Florida hurricane exceed $7 billion and will pay up to $17 billion in total. After more than a decade without major hurricane claims in the state, the FHCF has $14.9 billion in cash and $2.7 billion in catastrophe bond cover.
It also has private-market reinsurance of $1 billion, which kicks in after claims against the fund exceed $11.5 billion. This is provided by leading reinsurers, including Bermuda’s Renaissance Re with $375 million, Swiss Re with $175 million, and numerous others with much smaller lines. For the program to be hit, total hurricane losses from Irma will have to reach $18.5 billion. Modelers put Irma losses in the United States as high as $35 billion, so FHCF’s reinsurers may be called upon.
Another government-backed insurance facility to take a beating—or, in this case, a drowning—is the National Flood Insurance Program, run by the Federal Emergency Management Agency. It is technically insolvent after the losses it incurred when Harvey poured four feet of rainwater into the homes and businesses of Texas. The final count is not yet in, but NFIP faces claims in the region of $11 billion from Harvey alone, which has so far pounded the program with more than 88,000 claims. Irma sent NFIP another 25,000-plus claims. With $24.6 billion in debts to the Treasury and only $1.5 billion in the bank, the organization—which has received widespread criticism for undercharging for its coverage—must seek Congressional permission to borrow even more from the federal government. Washington is already considering a new, private-market approach to flood insurance, but initial efforts have been blocked by Congress. No one doubts, however, that U.S. flood insurance needs a serious rethink.
NFIP is not entirely reliant on government largesse. It has some open-market reinsurance, a proportional layer of $1.024 billion, which attaches after its first $4 billion in claims and pays 26% up to $8 billion. The reinsurance is placed with 25 global reinsurers and looks set to be entirely exhausted (modeler RMS put the burn rate at 75% to 100%). However, that risk sharing will still leave the federal program with a $10 billion tab. And that’s just from Harvey.
For more on NFIP, see “Under Water: Government Thwarts Private Participation in Flood Insurance” in the October issue of Leader’s Edge.
Another quite different facility will ease some of the most drastic costs faced by hard-pressed governments. The Caribbean Catastrophe Risk Insurance Facility (now called CCRIF SPC) is a sovereign disaster risk financing vehicle (or “cat pool”) supported by 16 Caribbean and Central American states. The world’s first multi-country risk pool, it covers earthquakes, hurricanes and excess rainfall. Several of its member countries have been hit hard by the hurricanes. So far it has announced payments to six countries, including $13.6 million to Turks & Caicos, $6.8 million to Antigua & Barbuda, $6.5 million to Anguilla, $2.3 million to St. Kitts & Nevis, and $19.3 million to Dominica.
More payments are almost certain to follow. The indemnities can be announced very quickly because policies issued by CCRIF pay out when a parametric threshold is triggered, such as wind speed of a land-falling storm, so actual damage need not be measured. The cash CCRIF provides is intended to provide governments swift liquidity rather than cover all the losses.
Across the Atlantic, state-owned French catastrophe reinsurer Caisse Centrale de Réassurance (CCR) has said Irma, which pounded the French Caribbean islands of Saint Martin and Saint Barthélemy, will cost an estimated $1.4 billion. Homeowners, auto, commercial property and business interruption will be covered under the French catastrophe reinsurance facility. CCR says the loss is one of the most expensive natural catastrophe events for France in 35 years.
Some forms of reinsurance, particularly instruments known as industry loss warranties (ILWs) and some catastrophe bonds, pay out to their policyholders (typically reinsurance companies themselves) when the industry’s total insured loss from a specific event or series of events exceeds a specified threshold. That makes the magnitude of the sector’s losses particularly important. It takes many months and sometimes years for the final cost of a catastrophe to be settled and calculated. Fitch Ratings has warned that the industry’s total catastrophe losses in 2017 could reach nearly $190 billion, though most put the total somewhat lower. Either way, it will be painful.
Losses at the “upper end,” Fitch said, “would be the highest on record in a single year.” The agency said those losses “could weaken capital at some (re)insurers and increase the risk of rating downgrades,” adding that “global reinsurers are likely the most exposed to these events.”
Catastrophe bonds, tradeable risk instruments funded primarily by pension and hedge funds, have seen volatility after the storms, and some will be triggered to pay their reinsureds. A.M. Best has estimated about $12.5 billion of catastrophe bonds are exposed to Florida windstorm losses, but Irma’s impact will be much less than that because these and other ILS instruments tend to cover only the highest layers of risk. ILS blog Artemis (with great caution, after Irma but before Maria) estimated the cat bond loss at $1 billion, but later estimates put the loss somewhat higher.
One sort of bond that is likely to be drawn down is the kind that responds to aggregate industry losses from named storms. Some bonds—such as XL Catlin’s Galileo Re 2015 issue—will pay out based on the industry’s combined loss from Harvey, Irma and Maria. XL Catlin’s drawdown will be up to $300 million. Meanwhile Fonden, Mexico’s state catastrophe insurer, expects to collect all of $150 million under a catastrophe bond issued through the International Bank for Reconstruction and Development and sold to private investors.
Most of the capital behind ILWs and cat bonds is considered “alternative.” It is provided by investors directly rather than through equity holdings in traditional reinsurers and is deposited up front in a special-purpose vehicle rather than simply promised, which almost entirely eliminates credit risk.
Most of the investors are pension funds. The volume of reinsurance capital invested in this way has skyrocketed in the past decade. It rose from $19 billion in 2008 to $89 billion at the end of June this year, according to Aon Benfield, or 15% of total global reinsurance capital. The reinsurance brokerage had noted a “renewed surge in alternative capital” just prior to the storms.
The way the providers of such capital react to losses—which has caused much navel-gazing in the traditional reinsurance market and has been a scapegoat for the perilously low level of catastrophe reinsurance pricing—will have an important bearing on the future of market pricing. Some believe the “once burned, twice shy” principle will apply, but others are less convinced. Should prices rise after alternative investors experience losses they always knew were possible, the reinsurance market may become even more attractive to them, causing the surge to swell. Since institutional investors tend to have lower return requirements for reinsurance capital than traditional reinsurers, they have a price-dampening effect. The medium-term impact remains unclear, although the first cat bond to be placed since the storms—a new “reloading” issue of XL Catlin’s Galileo Re issue—was priced above prevailing market rates for similar, earlier bonds.
What is now clear to all is that recent catastrophes will change the market. The long price decline is expected to halt and reverse, perhaps dramatically, for catastrophe-exposed U.S. risks and reinsurance business.
The events have also made clear that risk sharing works. The worst quarter on record for insured natural catastrophes has fallen lightly on the many and spared the few.