Natural catastrophes continue to shape the reinsurance market, especially US storms. In this special section, we look at the Florida market (p22), predictions about the 2009 storm season (p24) and the expected mega-losses of the future (p26). Plus, can the name of a storm really change insurers’ response to it? (p28)
We also assess whether insurers in Australia are making the right decisions after the country’s severe fires and floods (p30).
Sunny side up
Florida property renewal rates have risen about 10 to 15% despite a storm-free season last year. Liz Booth explains the background to current pricing trends
Florida had a storm-free season last year, leaving insurers and reinsurers breathing a sigh of relief. However, the Florida Hurricane Catastrophe Fund (FHCF) estimated it would have had a $14.5bn shortfall if a hurricane had hit, the result of unprecedented municipal bond market conditions in the global credit crisis.
The fund now is in a far better position and is estimating a range of post-event bonding capacity, with a best estimate of $8bn within the 12 months following an event.
This comes on the back of some major legislative changes that Aon Benfield says incorporates $10bn of Temporary Increase in Coverage Limits (TICL) for the new hurricane season – down from $12bn last year – and $2bn annual reductions in capacity to 2013.
This combines with a gradual increase in rapid cash build-up to the mandatory and TICL layers of protection.
The legislation also unblocks the rates freeze for the state-backed Citizens Property Insurance Corporation, a move that Aon Benfield says will increase its ability to compete with private insurers.
At the end of May, Florida Governor Charlie Crist signed legislation that increases property insurance rates for Citizens customers by 10% from January next year and by up to 10% per policy every year.
Meanwhile, two other bills are awaiting the governor’s signature. One modifies rate regulation in the state for well capitalised insurers; the other clarifies certain excess and surplus lines issues.
All of this set the scene for the 1 June reinsurance renewals, considered key in the US because of the Florida hurricane cover.
Bryon Ehrhart, chief executive officer of Aon Benfield Analytics, says that despite the financial turmoil of last year, most reinsurers have offered similar capacity to 2008.
“Reinsurers lost between 14% and 19% of capital in 2008. A year with catastrophe losses at expected levels will replenish capital within one year. A light catastrophe year will rebuild capital in less than a year – and the opposite is also true.
“Heading into the 2009 hurricane season, insurers appear more vulnerable than reinsurers because their capital bases have been more heavily impacted by the capital and liquidity crisis,” he says. “Reinsurers have offered capital relief transactions to the most vulnerable insurers and several have taken additional steps to protect capital.”
As a result, renewal pricing is at the “mid to lower end” of the ranges predicted earlier this year – about 10% to 15%.
Ehrhart says the market for the 1 June renewals was orderly and that insurers generally found the capacity necessary to renew their core programmes at prices, terms and conditions within their expectations and well below the peak pricing of June 2006.
AM Best analyst Richard Attanasio says the rating agency still has “concerns” about the state’s ability to bond the entire amount in case of a major event. But he stresses the concerns centre on a major event – such as Hurricane Andrew or Ike – and that cash reserves have built up since last year.
Attanasio says while there are these concerns, he is also aware that a major event, such as Katrina, does bring significant change. He says the legislators “had recognised the need to make changes and are beginning to do that”.
In the meantime, the renewal season has passed with enough reinsurance capacity for those that want it. “It is a matter of pricing. Primary insurers can find capacity but it is a matter of whether they can afford it,” he says.
A good wind blows ill
Scientists have scaled back their 2009 hurricane forecasts, but reinsurance renewals showed modest impetus for harder US windstorm rates, says Lee Coppack.
Florida property-catastrophe rates rose by 10 to 15% at 1 June renewals, according to brokers Aon Benfield and Guy Carpenter. It is a more modest increase than either expected, and follows a 15% reduction last year.
Many reinsurance programmes that cover significant Florida residential exposures are structured around the substantial loss reimbursements projected by the state of Florida through its Florida Hurricane Catastrophe Fund (FHCF). Changes in the resources available to the fund for 2009 increased demand for private reinsurance by about 5 to 10%. Although traditional reinsurance capacity declined by about 10% and the alternative market has contracted, there wasn’t sufficient imbalance to push rates up further.
The renewals took place shortly after the release of updated storm activity forecasts for the year. Tropical Storm Risk, an Aon Benfield-sponsored forecast group based in London, and Philip Klotzbach and William Gray at Colorado State University, scaled back their forecasts for the new season. With the National Oceanic and Atmospheric Administration (NOAA), they believe an average or near average season is the most probable.
No major hurricane has hit Florida for two years; damage from Ike last year was concentrated in the Gulf of Mexico and Texas. “The forecast for a below average level of storm activity does not necessarily have a direct impact on the price that companies pay for coverage or the level they choose to purchase,” says Lara Mowery, head of Guy Carpenter’s property specialty. “Whether or not overall activity is down in a given year, the industry may be impacted by only one significant event.”
As Karen Clark, president and CEO of Karen Clark & Company, points out, there is no correlation between the total number of storms and a really big landfall hurricane. Hurricane Andrew in 1992, the most expensive storm in US history until 2005, came in a year of below-average storm activity.
Benfield says that few new sources of capital have emerged this year, but the reopening of the cat bond market and limited signs of investor interest in sidecars and industry loss warranties are positive signs.
Among the deals, US specialty insurer Assurant issued its first transaction, a $150m bond to cover itself and subsidiaries against certain US hurricanes over three years. Swiss Re added a further $60m capacity for Atlantic hurricanes and California earthquakes for its own account and $100m for Swiss Re America, and the military personnel insurer, USAA, issued a further $250m three-year natural catastrophe bond.
Cory Anger, managing director of GC Securities, says the issuance doesn’t depend on seasonal forecasts. “Most catastrophe bonds commence structuring well before the 1 June annual meteorological forecasts for insurers/reinsurers to have protection by the start of the hurricane season. Plus, insurers/reinsurers utilise the catastrophe bond market not just because of the view of hurricane activity for the upcoming season.”
She adds that the early forecasts are not reliable as the sole input for hedging plans as they can expose insurers/reinsurers to substantial risks.
Florida’s growing population and development have steadily increased the values at risk in case of a hurricane, but the sharp drop in prices as a result of the credit crunch is not thought to have made a material difference in insurers’ exposures. There has been little change in replacement costs and the cost inflation expected following a major event.
Karen Clark believes attention should focus on mitigation, such as suitable building codes. “In a major catastrophe, you’d still have supply shortage and a demand surge.”
Budgetary constraints, however, have stopped the Florida state legislature this year funding the mitigation programme, My Safe Florida Home.
In Florida, the cost of homeowners’ insurance is an important political issue, and one of the state’s congressmen has launched another attempt to create a national consortium to spread the risk of natural catastrophes. The Homeowners’ Defense Act of 2009, introduced by Florida congressman Ron Klein, would allow about 30 state-sponsored catastrophe funds to sell cat bonds or buy reinsurance to cover potential future losses. The bill would also provide a federal guarantee for any debt that states incur paying for losses from a major disaster.
A range of interests such as environmental groups, conservative think tanks and the insurance industry are opposing the proposals. The Reinsurance Association of America (RAA) says that the legislation encourages the creation of state catastrophe reinsurance funds and disrupts the private reinsurance market. Despite this, Klein’s office believes prospects for proposed law are favourable, especially since President Obama co-sponsored similar legislation as a member of the US Senate two years ago.
Hurricane Ike, however, has battered the market for windstorm coverage for the offshore energy industry in the Gulf of Mexico, and the choices for companies operating there have narrowed sharply. Ike cost energy underwriters between $3.6bn and $4bn only three years after 2005 – the worst hurricane season of all when Hurricanes Katrina, Rita and Wilma devastated property in and around the Gulf of Mexico.
Hurricane Ike threw out model assumptions. “The big difference compared with 2005,” says James Sage, a partner in JLT’s marine, oil and gas division, “is that Ike was a category 2 storm with a damage spread of 250 miles. Katrina and Rita were less than that – although they were category 4 and 5 when they were in the Gulf. It showed that the potential for loss from a category 2 storm can be as bad as for a higher category storm.”
Retrocession has almost disappeared, partly as a result of the loss of two Bermuda facilities, including a subsidiary of the bankrupt Lehman Brothers. Reinsurance is “very, very expensive”, says Sage. Many insurers are running net, meaning they have no reinsurance. “Rates increased, and it became difficult to get extended well redrill, plug and abandon coverage associated with windstorm in the Gulf of Mexico,” he says.
The offshore market looks unlikely to change immediately because the economic fundamentals of insurance with reduced investment income are creating pressure for higher rates generally, adding to underwriters’ disincentives to devote capital to a minor but volatile class of business.
Lee Coppack is editor of Global Reinsurance’s sister publication Catastrophe Risk Management. www.cat-risk.com
The $100bn storm
Losses from weather-related events are growing each year. Many experts believe climate change is partly to blame, Helen Yates writes.
Climate change is expected to cause more extreme storms in the future and, in the developed world at least, reinsurers will bear the brunt of the economic burden. As the 2009 hurricane season gets underway, many wonder how long it will be before another Hurricane Ike or Katrina arrives.
Few in the scientific community doubt that climate change will impact weather in the future. According to the fourth assessment report from the Intergovernmental Panel on Climate Change (IPCC) in 2007, “the warming of the climate system is unequivocal”.
So we can expect increases in storm intensity, temperature extremes such as the heatwave that caused more than 52,000 deaths in Europe in 2003, and heavy rainfall, such as the summer downpours that led to widespread flooding in the UK in 2007. There will also be growing drought and decreases in water resources in subtropical and semi-arid areas.
As these extremes grow, the cost of claims will rise for the insurance industry.
This is already happening. Statistics show that overall losses and insured losses from weather-related catastrophes (after they are adjusted for inflation) have been growing since 1950. The rising cost is not all due to changing weather patterns; there is also the higher values at stake in catastrophe-exposed areas.
Florida is a popular example. “People like to live in risk-prone areas,” says Professor Peter Höppe, head of Munich Re’s Geo Risks Research Unit. “There is a clear movement of people from inland to coastal areas, especially in the US. In 1920 the population of Florida was 100,000; now it’s close to 19 million.” New York and Florida currently have the highest total insured coastal exposure in the world, valued at more than $1.9trn each.
In 2005 Hurricane Katrina generated the largest single loss in insurance history, costing $41.1bn. Together, the hurricane seasons of 2004 and 2005 were the worst on record. Seven of the ten most expensive hurricanes blew up in the 14 months from August 2004 to October 2005. Katrina, with Rita, Wilma, Charley, Ivan, Frances and Jeanne cost $79.1bn. But the worst has yet to come, says the Insurance Information Institute (III). Hurricanes costing $100bn will not be unusual in future.
Property catastrophe reinsurers were surprised at the magnitude of the losses from the 2004 and 2005 seasons. Some blamed the catastrophe models for failing to predict Katrina and many reduced their exposures to US catastrophes. Premiums shot up by 100% on certain lines, both a response to the contraction in capacity and to the revised catastrophe models. All three vendor catastrophe modelling agencies recalibrated their models to reflect heightened hurricane activity.
Although most scientists believe increased storm activity is a result of climate change, there is still some debate about the influence of a naturally occurring cycle, such as the Atlantic Multi-decadal Oscillation (AMO) cycle. Scientists think the North Atlantic oscillates between warm and cool phases every few decades. During a warmer phase, sea surface temperatures are higher, which results in more hurricanes.
But the AMO on its own is not enough to explain the growth in hurricane activity, says Höppe. “In the current warm phase we have about 50% more of these major hurricanes compared with the last warm phase. We cannot explain the total increase by having a warm phase – this is different.”
So how much is due to climate change and how much is the AMO? “Scientists don’t generally like to answer this kind of question,” says Robert Muir-Wood, chief research officer at RMS. “But if you’ve got leading climatologists in a room and you tell them ‘you can’t leave until you’ve answered it’ then I imagine they might say it’s about 50:50.”
From a catastrophe modelling perspective, it’s more important to gauge accurately the level of current activity than it is to analyse the underlying causes. “Much of what we do is building catastrophe loss models that look at risk today,” says Muir-Wood.
“So a lot of focus has been on, ‘has the activity of a particularly extreme event already changed?’ Given that the world is getting warmer, you can’t ignore the fact that it does change the occurrence of some classes of extreme events, but knowing exactly by how much is the challenge.”
Estimating the cost
The IPCC is preparing a special report on managing the risks of extreme events – including floods, droughts, storms and extreme temperatures – with the aim of helping governments and communities to adapt. Ahead of this year’s United Nations Climate Change Conference in Copenhagen in December, a number of bodies are trying to put a price tag on the cost of such future perils. These endeavours are filled with uncertainty but should aid policymakers in their mitigation and risk transfer discussions.
Forecasting for hurricanes remains difficult because, as Muir-Wood says, forecasters are not just looking at mean climate in the future, but actually the extreme climate.
Munich Re has estimated that about 30% of the rise in weather-related losses is due to climate change. The figure is based on the total global increase in natural catastrophe losses each year,
considering inflation and growing insured values. The reinsurer hopes to gain more accurate figures through a five-year collaboration with the London School of Economics and Professor Lord Nicholas Stern.
The initial findings are due out this summer and will include new findings on the economic impact of
climate change. “We think it’s the largest problem for mankind in this century that we have to solve,” says Höppe. “So we do all we can to provide business solutions – to provide tailormade insurance products – but also on the political level to communicate with decisionmakers and do all we can to support climate protection measures.”
Paying for catastrophes
Risk transfer mechanisms will feature in the UN’s climate change talks in Copenhagen. In the developed world, the private reinsurance market covers most catastrophe exposures. In peak zones, such as Florida wind, capital market solutions such as cat bonds and sidecars can provide additional capacity.
In the developing world there are a different set of challenges, with many catastrophe risks underinsured. Total losses from the Sichuan earthquake in China last year are expected to exceed $20bn, but only 5% will be covered by insurance. One popular solution for the future is to establish catastrophe pools with both public sector and private sector backing.
A number of countries have put together catastrophe pools and the first multi-national cat pool has been set up in the Caribbean. The Caribbean Catastrophe Risk Insurance Facility (CCRIF) provides 16 countries with cover against hurricanes and earthquakes and was set up by the World Bank, with donations from its members and a number of supporting governments. Risk is transferred to both the traditional and capital markets with payouts based on parametric triggers.
Such a model could be used for the rest of the world, says Dr Simon Young, CEO of Caribbean Risk Managers, the facility supervisors of the CCRIF. He suggests a global-scale catastrophe risk pool to “be capitalised by polluting countries”, which would help compensate developing countries for losses from extreme events.
Helen Yates is a freelance journalist
Look out for 'Bill'
Could a hurricane’s name change the behaviour of insurers? Whether it is psychology or superstition, names can make a difference, as Lauren MacGillivray finds out.
Look out for Bill… or should we say look out for “the bill”? Indeed, the second storm name for 2009 could spell significant losses for the insurance industry – so could any of them.
But can the name of a storm really affect the way claims are made or even the way insurers prepare and respond to such a catastrophe?
Professor Cleveland Kent Evans, an expert in the psychology of names, says names can help to increase sensitivity to a forthcoming event, but believes the 2009 Atlantic storm list is a missed opportunity.
“To me, as a 57-year-old American, none of the names on the 2009 list sound really fearsome. I think that particularly goes for Danny and Mindy.”
Evans, a professor at Bellevue University in Nebraska and author of Unusual and Most Popular Baby Names, added: “I wish the meteorologists wouldn’t use names like that. Pet forms ending in ‘y’ or ‘ie’ sound too infantile for hurricanes...Dan would be much better than Danny, in my opinion.”
The World Meteorological Organisation (WMO), a United Nations agency, maintains the lists of hurricane names. Its international committee represents the 10 hurricane regions – Atlantic, Eastern, Western and Central North Pacific, Papua New Guinea, Southwest Indian Ocean, Australia, Philippines, Fiji and Northern Indian Ocean.
The lists of hurricane names for each region have been long established. But a name is struck from the list and changed if a storm is so severe that it would be insensitive to use it again. Six lists are used in rotation for the Atlantic. The 2009 list, for example, will be used again in 2015. But Ike won’t be back after the destruction and loss of life last year.
The National Hurricane Center believes that “short, distinctive given names in written as well as spoken communications are quicker and less subject to error than the older more cumbersome latitude-longitude identification methods”.
Jim Bruning, trustee professor of psychology at Ohio University and an author on the psychology of names, says names with hard consonants sound more active, while soft consonants are more passive. He agrees that the 2009 list is on the soft side.
“Looking at the 2009 list, I don’t see any that really sound like hurricane names.” As he says, Ana, Claudette, Danny, Grace and Larry just don’t do it for him.
But he concedes that it all depends on your perspective: “Whether or not a name is fearsome is going to be different depending on your culture and even, to some extent, what generation you are.
“The present Atlantic lists are supposed to contain names from French and Spanish-speaking cultures as well as from English-speaking culture. I don’t know whether any of the names sound fearsome to someone in Haiti or Mexico.”
Insurers and reinsurers insist their approach is purely subjective – they do not allow the name or reputation of a storm to affect the analysis of storm losses, says Peter Höppe, a professor and head of Munich Re’s geo risks research unit.
“We don’t believe in any magic of names,” he adds.
The names are English, Hispanic, French or Dutch because those are the most common nationalities throughout the Atlantic basin through history. Men’s names were added in 1979.
Lauren MacGillivray is a freelance journalist.
A spate of natural catastrophes in Australia has pushed up reinsurance coverage. But are insurers Down Under becoming too cautious and over-protected on catastrophe cover, asks Kate Tilley.
Australia has seen unprecedented losses since
the start of 2009, dominated by a spate of fatal bushfires near Melbourne, Victoria, in February.
Added to this were storms, droughts and severe flooding events in Queensland and New South Wales. By the end of May, more than 10,000 bushfire claims had been made, with an estimated insured cost of $A1.07bn, according to figures from the Insurance Council of Australia (ICA). Almost the same number of storm claims is expected to cost $A39m. No surprise then that reinsurance rates are expected to rise at the next renewals, but many say this will only be in line with global trends.
However, one definite change is in the structure of contracts arranged by the domestic insurance industry, dominated by QBE (Australia), Insurance Australia Group (IAG) and Suncorp.
Reinsurance broker Paul Allison says Australia’s catastrophe losses in the international reinsurance market are “a pimple”, compared with the losses for Hurricane Katrina. But Allison, chief operating officer at Guy Carpenter & Co in Sydney, says Australian insurers are over-cautious, buying more catastrophe protection than they need. He says the market is “overly concerned with multi-zone, multi-peril cover” and insurers are “perhaps frightened of falling foul” of the regulator, the Australian Prudential Regulation Authority (APRA). Allison estimates that the Australian market’s
aggregate stands at $A20bn-$A25bn of catastrophe cover. “It’s very hard to envisage an event of that size
affecting the industry over and above the capital buffer already in place under APRA guidelines,” he says. “We have had the worst fire storm ever, a nasty, tragic situation, and the insured loss is about $A1bn. Something five times worse is still only going to be $5bn.”
Siddharth Parameswaran, an insurance analyst with stockbroker JP Morgan, says the bushfires will breach all major insurers’ maximum event retentions (MERs).
While Parameswaran says Australian insurers would prefer to pay higher rates than retain more risk, they are unlikely to pay more than the global rate for catastrophe cover.
“There will be some increases in prices; it’s a global trend,” he says. However, he added that events might change in advance of the major IAG and QBE
reinsurance renewals at the end of 2009.
Last year, QBE Group’s cost of reinsurance protection decreased from 17% to 14%, as a percentage of gross earned premium. This was due to “synergies from new acquisitions” and increased participation of QBE’s Bermuda-based captive reinsurer, Equator Re, the insurer said.
QBE’s reinsurance programme includes a new group aggregate cover for large individual risk claims and catastrophes, which the insurer says is
“beneficial given the level of large claims in 2008”.
It purchased additional reinsurance for three years from 1 January, 2008, providing cover of between 8.5% and 9.9% of targeted net earned premium.
IAG has said that the February bushfires exceeded its initial domestic MER of $A126m. Michael Wilkins, the company’s CEO, says that flooding and storm damage will not trigger this second event MER of $A75m, but will “contribute to the erosion of the deductible of the group’s aggregate cover”.
IAG has reinsurance cover of $A150m for aggregate events exceeding $A150m. But aggregate event costs totalled $A100m by early June, including the bushfires and storms.
IAG’s main catastrophe reinsurance provides cover in excess of the retention for losses up to $A4bn. IAG renewed its property catastrophe aggregate cover, which provides protection for accumulated losses from events larger than $A15m and up to $A50m, on 1 January.
Kate Tilley is a freelance journalist.