62: Reinsurance Market Provides Critical Global Catastrophe Support

The US based primary and reinsurance markets cede about $60 billion of risk premiums to alien reinsurance carriers each year to help leverage the inherent catastrophe and excess risk accumulations. There has been wide discussion and potential government intervention on this issue particularly of risk placements with affiliated companies that allegedly avoids the payment of US tax. Most often the arguments fail to understand the business purpose, operational benefits and risk management principals behind the strategic usefulness of those facilities. While we have commented on this aspect previously*, the purpose here is to look at the catastrophe risk benefits of global reinsurance to the US private market carriers and their ability to underwrite US risk business.

Obviously the industrialized and mature economies are the greatest sources of commerce and as such represent the places where a high level of local insurance protection takes place. Unfortunately, they also provide the greater risk exposure opportunities to loss of assets both from the accumulation of values at risk as well as the exposure to natural catastrophes around the world. (see Newsletter #26 on reinsurance tax issues).

GLOBAL CATASTROPHE EVENTS

There are significant natural catastrophe events that take place around the world to which the private insurance and reinsurance can respond with financial resources to rebuild and replace damaged property and loss of income. The chart below indicates some measurement of 2009 and 2010 catastrophes along with the 10 year and 30 year long term averages.

While the total number of events above were not materially different there is substantial volatility in the total losses, amount recovered from insurance and the loss of human life. We can better see the volatility that can occur by looking at loss data from 2011 to date below.

This clearly shows that 2011 will be among the more serious catastrophe periods on record considering that we had billions of other losses outside the U.S. that are not shown above. In addition, the estimated economic losses from the earthquake in Japan, doesn’t include the full measure of indirect losses suffered around the globe. As a result of the interruption of material part supplies from Japan manufacturing capacity elsewhere was delayed or lost.

U.S. NATURAL CATASTROPHE LOSSES-2011

Our recent attention has been drawn to the unusual level of recent natural catastrophe losses in the United States and the possible impact to the stability and cyclical pattern of commercial market availability and rates. The following chart provides the latest information on U.S. 2011 catastrophe losses keeping in mind that statistical data on many events is still not definitive. 

The type of events, in part, determine  just how much the private insurance market will be obligated to pay on such claims. The amount of private market participation can often be mitigated by situations that involve losses that are outside commercial and personal property limitations for recovery. These might include any of the following:

• Infrastructure property such as roads, bridges, forest and publicly owned properties that do not usually carry private insurance coverage;
• Buildings, structure and equipment owned by state or municipal governments some of which may be self insured;
• Property covered by the Federal Flood program are protected by funds from FEMA and only administered by the private market;
• Economic or indirect losses involving business income, loss of use, supply interruption or discontinued operations that may not be recovered under insurance terms;

The most common reason for the low percentage recovery is often related to events involving flooding. Floods are not covered in the private market for individual homeowners and small business property owners but are available via the federal FEMA Flood Program that currently is running huge deficits.

WHAT IS THE PRIVATE MARKET CAPACITY TO UNDERWRITE THESE GLOBAL CATASTROPHE RISKS?

This is a logical question given the recent history and size of events that have taken place around the world. In our Newsletter #53 we attempted to aggregate the private market global risk capacity which we indicated at $1.624 trillion. This took into account all available private primary, excess and reinsurance facilities as well as potential capital market availability. It did not attempt to identify pure catastrophe capacity except to include existing capital market facilities such as Catastrophe Bond securitizations and Special Purpose Vehicles (SPV) such as “side-car” companies. These latter risk bearing facilities are usually dedicated for catastrophe related exposure or risk accumulation relief much as traditional quota share reinsurance. But unlike traditional reinsurance the investors are not committed to an open ended organizational life and do not require an operational/support staff given the nature of the transaction with the ceding carrier.

Commercial primary market carriers generally write a multiline (i.e. property and casualty) combined book of business although some markets do specialize in writing primarily property risks especially in sectors such as large industrial risks or oil and gas. Other large insurance carrier groups may have operations in both primary and reinsurance markets and the division of capital specifically dedicated to property catastrophe business may not be easily identified. One major reinsurance broker, in an effort to gauge that specific segment, has estimated the composite global reinsurance dedicated capital at $168 billion. In the U.S. the domiciled primary market capital at last count was $445 billion (excludes U.S domiciled mortgage and reinsurance carrier sector capital of $119 billion-see Newsletter #59) but that supported all of the primary writings across many retail lines of insurance including property risks with catastrophe potential. In a recent report by Aon Benfield they indicated worldwide P&C GWP* in the top 50 country markets at $1.148 trillion (US portion $456 billion) with property risks GWP equal to $374 billion. So property risks that represent about one-third of the world premium market, appear adequately supported by the capital base on a 3:1 ratio it does not take the catastrophe variability into account. The global catastrophe reinsurance market essentially exists in order to take excessive risk away from local markets with the exact amount of “excess” being an individual insurer’s judgment based on their business expectations of written business and resources to meet contingencies. The ability of global reinsurers to effectively compete in that market is based upon their superior resources, understanding local impact of global risks and their ability to attract a proper spread of business to manage their own financial risk.

*in our Newsletter #53 we used data from a Sigma #2 report on 2009 world wide premiums that indicated global non-life premiums of $1.742 trillion(U.S. portion $648 billion) that included sectors such government sponsored programs (FEMA; California EQ Authority), accident-health insurers, State WC facilities, domestic captive insurance market etc.

ARE THE RISKS TOO BIG OR IS THE POTENTIAL REWARD TOO SMALL?

This could be the question underlying the reason for governments to engage in insurance-like activities when there appears to be an insufficient response from the private insurance market. The private insurance industry works best when it can help to mitigate exposures through risk management and loss prevention methods that ultimately help to drive down the cost of insurance making it more affordable. This has been the case with earthquake modeling that has helped in the development of engineering standards so buildings can be more resistive to earthquake damage. Deficiencies in building code development and enforcement became apparent following Hurricane Andrew in 1992. This caused an increase in damageability then previously estimated but led to subsequent improvements in construction techniques and materials. This has not been the case with floods where commercial and residential development in areas prone to flooding or susceptible to coastal windstorms has left properties consistently in harms way. State Government backed FAIR plans and Beach and Windstorm plans with exposures of $54.7 billion in 1990 have now reached $757.9 billion in 2010. In addition, the Federal Flood program has been in the red since it’s’ $16 billion in flood losses from Hurricane Katrina and as of today owes $17 billion to the Treasury Department. It has never operated based on traditional underwriting and rating principles and has become the proverbial “kick the can down the road” funding debate every 3 months Congressional fiasco! Government programs keep these risks outside the private insurance market as their inaction on risk containment and methods of  resource management to pay for claims can only be achieved by having access to taxpayer funds…..the private insurance market has no such benefit available to it.