Last year’s Hurricane Sandy caused approximately $20 billion in insured losses. Notwithstanding the devastating loss of life and extensive property damage, Sandy was not a true tail catastrophe event from a U.S. perspective.
Tragically, events of Sandy’s magnitude are not actually that rare. It was the location of the event that made the damage so significant. Still, Hurricane Katrina in 2005 caused even greater damage and loss of life and events more devastating than Sandy and Katrina are also possible.
The 2013 Atlantic Hurricane season begins on June 1st. While one can hope for the absence of the destructive land falling hurricanes, many experts predict an active 2013 season.
What if they are right? What if not only are they right but Miami gets hit by a monster Hurricane Karen (one of the 2013 names)? Could industry insured losses exceed $100 billion? Some think they might. Then what? Will all claims get paid? Will premiums skyrocket?
Testing the Promise to Pay
With the rise of alternative capacity in the cat bond and collateralized re markets, pundits say a lot about who and what will happen after the big event. The first thing is very clear . . . the insurance industry will for the most part respond quickly and efficiently to pay claims and help policyholders. This is what the industry does best.
Most of the companies should have adequate claims paying resources but some could face shortfalls. If either a private reinsurer or the Florida Hurricane Catastrophe Fund have a surplus shortage, a cascade of insolvencies could follow. The extent to which the “promise to pay” results in actual payments will surely be tested for a true tail event.
Note that to the extent insurers accessed capital markets capacity, either in the form of collateralized reinsurance or via cat bonds, they will have mitigated counterparty risk. For capital markets capacity, the limit is typically fully collateralized with Treasury Money Market funds or similar instruments with minimal credit risk.
Will a Hard Market Follow? Do the Capital Markets Have a Glass Jaw?
Hurricane Andrew, 9/11, and Hurricane Katrina all lead in varying degrees to a hard market. In contrast, Sandy did not. Even 2011’s tragic earthquake in Japan with estimated industry insured losses of $35 billion had limited impact in the reinsurance markets outside of Japan.
An open question is whether a hard market would follow a $100 billion Hurricane Karen in 2013. Our view is that the presence of the capital markets capacity should blunt the emergence of a hard market. This assumes that the hurricane rather than the tort bar or the government causes the losses. If a $25 billion event turns into a $100 billion event because of mold, sink holes, and the disregard of flood exclusions rather than the hurricane itself, investors may step away as their view of risk and return will change.
A crucial but largely unasked question is not whether the investors will take more risk following the big one but whether the traditional reinsurers will have capacity to take more risk in tandem with the investors. Some reinsurers (and/or startups) may have limited access to additional equity capital based on a combination of recent relative stock market performance (some reinsurer stocks still trade at a discount to book). Others will use a combination of sidecar, collateral re, and cat bond capacity to rebuild their risk taking capacity. Those who have not planned for this by engaging with investors in advance may be left out and need to withdraw from the market (proving that they not the investors have the glass jaw).
The insurers who have relied exclusively on long term relationships with traditional reinsurers and have failed to develop direct relationships with investors via cat bonds or otherwise could be at a disadvantage. In contrast, insurers who have developed broad relationships with both traditional reinsurers and investors as the source of sustainability may be better positioned.
Whatever happens between June 1st and November 30th, insurers, reinsurers, and investors stand ready to do their part to help policy holders. Of course, everybody would be better off if a hypothetical Hurricane Karen followed its 2007 predecessor and stayed at sea instead of making landfall in the US.
Willis Capital Markets & Advisory (WCMA) is a marketing name used by Willis Securities, Inc. (WSI), a licensed broker dealer registered with the U.S. Securities and Exchange Commission and member of FINRA and SIPC, and Willis Capital Markets & Advisory Limited (WCMAL), an investment business authorized and regulated by the UK Financial Services Authority. Both WSI and WCMAL are Willis Group (Willis) companies. Securities products are offered in the U.S. through WSI and in the U.K. through WCMAL. Readers should not place any reliance on any forward-looking statements, noted by such words as “should,” “may,” “expect” and “believe” contained herein. WCMA is not providing any advice on tax, legal or accounting matters and the recipient should seek the advice of its own professional advisors for such matters. Nothing in this communication constitutes any legal or financial advice or an offer or solicitation to sell or purchase any securities. Information contained in this communication is based on sources believed to be reliable, but no representation is being made as to the accuracy or completeness of such information. Unless otherwise indicated, any information contained in this communication is as of its date only and is subject to change.