Capital markets continue to be willing providers of capital to reinsurers assuming US natural disaster risk. In addition, other financial products such as catastrophe bonds are increasingly being used

Insurers and reinsurers have paid record amounts for US natural disaster losses in 2004 and 2005. In spite of that fact, the private sector reinsurance markets are providing record amounts of reinsurance capacity.

Even with these substantial losses, the year-over-year supply of reinsurance increased as some reinsurers added capital and new reinsurers formed.

Capital markets continue to be willing providers of capital to reinsurers assuming US natural disaster risk. In addition, other financial products such as catastrophe bonds are increasingly being used.

While capacity remains satisfactory for most regions and perils, reinsurance capacity is temporarily short of the heightened new demand in Florida. The supply/demand equation has historically re-balanced over time. Proposed state and federal natural disaster reinsurance programmes may impede this natural economic cycle. They should not crowd out private sector risk transfer capacity. As we learned with Hurricane Andrew in 1992 – the last paradigm shifting event for hurricanes – markets need time to adjust, but they are resilient and the supply/demand equation will come back into balance.

A review of 2004 and 2005:
Summary: Record setting losses, large distribution of losses to worldwide reinsurance markets. Many reinsurers needed to raise additional capital to support future business opportunities.

Catastrophe modelling changes:
RMS May 2006 revises catastrophe modelling formulation:
● Based on new data from eight storms in two years, 1/250 event PML increased $55 billion
● RMS estimates the additional insurance capital needed to support this PML increase at $82 billion

Rating agency changes
● A.M. Best revises catastrophe scenario tests needed for insurer ratings
● Standard & Poor’s applies reinsurance catastrophe scenario testing to primary insurers

Net effect: additional capital needed just to support the same book of business as written in 2005 if the insurer wants to maintain its financial strength rating.

Exposure increases 1000 additional residents are moving into Florida each day, creating new demand for housing, particularly along the coast. Other States in the South East of the US are also showing growth.

Underwriting analysis:
Looking backward
● Revised future loss expectations based on actual loss experience
● Poor commercial lines underwriting data led to mistaken assessments of loss potential
● Underwriting data is slow to reflect the increase in the number of insured properties in peak zones due to housing construction boom
● Insurance to value errors, premium collected was incorrect since the cost to rebuild exceeded expectations due to insurance limits failing to keep pace with costs of construction and market value of property

Looking forward
● Revised loss frequency expectations based on North Atlantic hurricane cycle
● Revised severity expectations based on continued exposure growth, demographic changes and demand surge.

This Special item appeared in issue 109 of JTW News - October 2006

Author: Brad Kading | Frank Nutter - (ABIR) | (RAA)