Financing catastrophe risks amid economic woes

I.I.I. and Swiss Re Webinar examines the perfect storm created by a record number of natural catastrophes and the current economic crisis

By Phil Zinkewicz

The property and casualty insurance business is haunted by a number of specters on a fairly regular basis. The tort liability situation is one of them. When lawsuits are on the rise, insurers can expect to see some red ink in particular lines of business. Catastrophic occurrences represent another apparition that causes insurance bottom lines to go bump in the night.

But these days, insurers have more than just the usual ghosts to contend with. As the expected loss producers continue to shout “boo,” insurers also have to deal with a faltering economy that is howling like a banshee.

In June of this year, Swiss Re and the Insurance Information Institute (I.I.I.) hosted a Webinar titled “2009 Hurricane Season: Financing Catastrophe Risks Amid the Economic Crisis.” The Webinar included: Dr. Robert P. Hartwig, CPCU, I.I.I. president; Bill Dubinsky, director of P&C Insurance Linked Securities for Swiss Re Capital Markets; and Dan Ozizmir, managing director and head of Insurance Linked Securities for Swiss Re Capital Markets.

In a joint statement preceding the Webinar, Swiss Re and the I.I.I., noting the beginning of the hurricane season, said: “Insurers have more than the usual frequency and severity of storms to consider. The economic turmoil that began in late 2007 brought substantial challenges to every industry, including the insurance sector. In the past, insurers had to contend with major events such as Hurricane Katrina or steep economic downturns, but rarely have both occurred simultaneously. Nevertheless, property/casualty insurers and reinsurers have risen to the challenge. In fact, even as the global financial meltdown intensified during 2008, insurers paid $26 billion in natural catastrophe losses—the third most expensive year in United States history.”

Hartwig, in his presentation, addressed capital adequacy, invest­ment market volatility, impacts of the prolonged recession on industry financial performance and potential changes in the regulatory environment. He also discussed the resiliency of the property/casualty insurance sector in comparison to the banking industry.

Capital has become much scarcer, according to Hartwig. “Though still adequate, existing U.S. P&C capital base shrank by 12.9% as of year-end 2008,” he said. “Capital has become more expensive. Scarcity and volatility have driven cost of capital higher, and there is more competition on the open market for the limited amount of capital available.”

Hartwig said that state-run residual markets are more vulnerable as the result of shaky financial arrangements. “For example, Florida’s situation is more precarious than ever and growing, threatening the state’s finances.”

Addressing financial services regulatory overhaul and how the business of insurance is regulated, Hartwig said that it is yet unclear how CAT losses would be financed. “Will the federal government play a bigger role in financing CAT risks?” he asked.

Hartwig said that, in 2008, insurers paid $26 billion to 3.9 million victims of 37 major natural catastrophes across 40 states. Sixty-four percent of the payouts went to home owners, 27% to business owners and 9% to vehicle owners. Texas by far had the largest payout at $10.2 billion, followed by California at $2.2 billion, Minnesota at $1.6 billion, Ohio at $1.3 billion and Georgia at $1.0 billion, according to the I.I.I. president.

“Eight of the 10 most expensive hurricanes in U.S. history have occurred in the past five years, as have nine of the 12 most expensive disasters of all types,” said Hartwig. “In 2008, Hurricane Ike became the sixth most expensive insurance event and fourth most expensive hurricane in U.S. history.”

Turning to U.S. policyholder surplus, Hartwig said that actual capacity as of year-end 2008 was $455.6 billion, down 12% from year-end 2007 at $517.9 billion, but still 60% above the 2002 trough. “The premium to surplus ratio stood at $0.95 to $1 at year end 2008, up from a near record low of $0.85 at year end 2007.”

Regarding the current economic situation, Hartwig said that the financial crisis now ranks as the second largest “capital event” over the past 20 years. He said that, in the wake of Hurricanes Katrina, Rita and Wilma, $33.7 billion in capital was raised and that fully two-thirds of that amount was from non-traditional sources. Hartwig, however, questioned whether similar sums could be raised in 2009.

Finally, Hartwig discussed how insurance industry stability has benefited consumers. “Insurance markets, unlike banking, are operating normally,” he said. “The basic function of insurance—the orderly transfer of risk from client to insurer—continues uninterrupted. This means that insurers continue to pay claims, whereas 61 banks have gone under as of 5/31; renew existing policies while banks are reducing and eliminating lines of credit; write new policies, while banks are turning away people who want or need to borrow; and develop new products while banks are scaling back the products they offer.”

Ozizmir and Dubinsky also discussed the 2009 hurricane season amid the current economic crisis. They said that the Lehman Brothers’ bankruptcy and general market conditions have caused market growth to slow in the areas of hedge fund de-leveraging and challenging relative value comparison to comparable products. “New collateral structures introduced in 2009 have addressed investor concerns and issuance has resumed,” they say. “Issuers are willing to pay higher spreads for the collateralized capacity. Insurance-linked securities (ILS) rates and reinsurance will converge during the latter half of 2009.”

The Swiss Re executives also said:

• Hedge funds that solely focus on ILS are dominating the sector and continue to raise capital despite the turmoil in the broader financial markets.

• Money managers and pension funds continue to see value in the diversifying aspects of ILS.

• Multi-strategy hedge fund participation is currently less than historic levels as these institutions have come under pressure.

• Capital has become dearer and hurdle return rates have risen along with other markets, but ILS continues to benefit from low correlation.

• Overall, the investor base has remained healthy and engaged.

Ozizmir and Dubinsky said that the insurance industry’s capital has been depleted. “Falling equity markets, credit spread widening, and asset impairments have caused significant realized and unrealized losses,” they said. “Industry capital has shifted from excess to tight. The cost of capital has increased substantially. Equity markets are depressed and hybrids are expensive,” they said.