Analysis:
Reinsurers at Risk If Hurricane Season Is Big

Posted: 7/8/2011

Source: REUTERS: Insurance Journal

By Ben Berkowitz and Sarah Mortimer

A major hurricane landfall in Florida could strain leading global reinsurers that have already been buffeted by brutal tornadoes in the United States and earthquakes in Japan and New Zealand.

The biggest reinsurers, companies like Munich Re and Swiss Re and Bermudan heavyweights like ACE and XL , could be forced to stop returning money to shareholders, and might even look to raise new capital. Industry surpluses — the companies’ cushion against losses — could be tested.

The global reinsurance industry has already suffered more than twice the losses that were expected for the whole year, insurance brokerage Guy Carpenter recently estimated. Record earthquakes and unprecedented tornadoes are among the natural disasters that blindsided the $464 billion industry.

And now, perhaps, it gets bad.

Before this year, eight of the 10 costliest natural disasters in history were hurricanes. There is broad consensus that the United States is overdue for another major hurricane to make land.

“Typically we see five or six hurricanes but with the conditions forecast we could see as many as eight to 10,” said James Elsner, director of the Hurricane Climate Lab at Florida State University.

If a hurricane does hit Florida, it will likely be stronger and do more damage than past hurricanes, Elsner said. A big one could cause $20 billion or more of insured losses.

July 1 is one of the major renewal points for annual reinsurance contracts, and while there is some evidence of firming, broker Willis Group said this week there was a wide variation in the kinds of prices being quoted.

“You’re looking at about $70 billion of loss, which is getting very close to meeting if not exceeding where 2005 was,” said Gary Prestia, chief underwriting officer for North America at reinsurer Flagstone Re. The industry suffered brutal hurricanes, including Katrina and Rita, in 2005.

“It would actually take a much lower industry loss event this year to really push it over and establish it as the worst year ever this year.” Prestia added.

Others in the industry believe reinsurers have already reached the point where catastrophes will force them to pay out. Insurers themselves may be cheating by not setting aside enough money to cover losses, in an effort to protect near-term profits.

“I agree with (the analysis) on the cheating phase, and if we’re in the cheating phase, then the surplus declared on the balance sheet is not as big as it might first appear,” said Stephen Catlin, whose eponymous firm runs the largest syndicate in the Lloyd’s of London market, with around 1.43 billion pounds in capacity.

“If you thought that there was a systemic issue of cheating, then let’s say that the $75 billion surplus is down to $25 billion. Having had approximately $75 billion worth of (natural catastrophes) this year so far, $25 billion doesn’t seem to me to be that big a surplus. The market is probably a lot shorter of capital than many of the pundits are saying.”

OUTLOOK STORMY

More than other states, Florida is considered a huge risk point. In the state’s most vulnerable regions, especially high-value areas like Miami, the dominant insurer is the state-owned carrier Citizens Property Insurance Corp.

If Florida Citizens needs reinsurance, it gets much of that coverage from the Florida Hurricane Catastrophe Fund — which would fund any payouts it had to make by issuing billions of dollars in municipal bonds after a major hurricane has already struck. Reinsurers are still exposed though, especially this year, as Citizens tapped private markets as well for coverage.

The other problem for the industry is a piece of software known as RMS Version 11 (V-11).

The latest iteration of the catastrophe model developed by Risk Management Solutions, it predicts losses on Florida hurricanes about 6.5 percent higher than historically forecast. Given how many insurers rely on RMS for their modeling, the change has shaken the industry.

This development, as well as the unprecedented amount of catastrophe losses seen so far this year, has led to a rise in demand for ‘back-up covers’, said Flagstone Re’s Prestia.

“Some regional carriers have exhausted part of their catastrophe program and are looking for back-up cover for the remainder of the year,” he said.

With the associated increase in risk that RMS forecasts for reinsurers, firms have been turning to alternative forms of protection to fill capacity gaps.

The industry has raised $2.3 billion through “sidecars” – specially created subsidiaries funded by outside investors. Demand for Industry Loss Warranties, which allow reinsurers to buy protection against catastrophe losses from hedge funds, are up by 30 percent.

“The market losses have brought the market close to a tipping point, but has not yet become a significant capital depletion event,” said Cory Anger, managing director and global head of ILS structuring at GC Securities.

(Additional reporting by Myles Neligan, editing by Dave Zimmerman)

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