Exposure to loss of property insurers of last resort nears $900 billion

The potential size of the exposure faced by U.S. residual market property insurers of last resort has risen to new highs as total exposure of these types of insurers nears the $900 billion mark. While these are supposed to be insurers of last resort, the Insurance Information Institute (I.I.I.) says in a recent report that they are becoming the first choice among many of the nation’s insurance consumers with as many as 3.31 million home and business owners using a residual market insurer in 2011.

The $900 billion of exposure that sits in this part of the insurance market is an enormous figure, larger than the entire global reinsurance market which many people estimate as being around $300 billion in size. It looks an even bigger number when you realise that these so-called residual market insurers were established to pick up the slack in regions that insurers could not operate in due to catastrophe exposure which made rates unaffordable.

The figure of 3.31 million residential and commercial policies which were offered by state-run insurers of last resort in 2011 was up 17% from the 2.84 million policies of 2010, showing that these insurers are gaining far more market-share in the U.S. than they were originally designed to.

According to the I.I.I.’s report, Residual Market Property Plans: From Markets of Last Resort to Markets of First Choice, the residual market insurers are gradually shifting their business model as they grow. “Today, many residual property market plans have shifted away from their original mission as insurers of urban properties into major providers of insurance in high-risk coastal areas. It is important to recognize that many operate at deficits, or from slim positions of surplus, even in years with little or no catastrophe losses,” write the report’s co-authors, Dr. Robert Hartwig, president of the I.I.I. and an economist, and Claire Wilkinson of the I.I.I. “A variety of factors are at play here, including the fact that state plans may be prohibited from charging a rate that is commensurate with the risk being assumed.”

The 3.31 million U.S. residential and commercial property insurance policies in-force in 2011 were primarily acquired from one of the 30-plus Fair Access to Insurance (FAIR) Plans or six Beach and Windstorm Plans, the report states. The cumulative total exposure to loss in the U.S. residual property insurance market grew to a record-high; $884.7 billion in 2011, up 17 percent from 2010’s $757.9 billion figure and higher than the previous record of $771.9 billion, set in 2007, the I.I.I.’s white paper states. Florida Citizens is responsible for more than half of these policies, 1.7 million.

The problem is that with all this exposure, considerably more than the total reinsurance market could assume, the claims-paying capacity of these residual insurers can be limited and nowhere near enough to support major disasters such as severe hurricanes. In the past they have relied on their reserves and lending from the government to pay claims after major events, then paying back government loans by imposing assessments on policyholders increasing the cost of their policies. Post-event bond issuances are also another method these insurers use to meet claims obligations, but there is a growing push for them to be more proactive in their risk transfer arrangements. Now, some of the plans are purchasing reinsurance to provide them with some claims paying ability and we’ve even seen a number of catastrophe bonds being issued over the last few years.

Sound familiar? We’ve written many times about this exact phenomenon in reference to Florida Citizens and also the Florida Hurricane Catastrophe Fund, where the state backed insurers have been prohibited from raising rates to reflect the true risk a policy faces. This has led to some dislocation in the market in Florida both in insurance and the reinsurance market, making it difficult for other insurers to operate and for reinsurers to participate in the residual market risks. As we said, this is changing gradually and reinsurance is becoming more of a focus for the insurers of last resort as they come under increasing pressure to take the burden off the state and their policyholders. Interestingly, as many of our readers will be aware, Florida Citizens has recently begun to take on more reinsurance coverage including the massive Everglades Re Ltd. catastrophe bond, so perhaps the size of the exposure is beginning to be taken more seriously.

In the 2005 hurricane season, private reinsurers only shouldered around 45% of the total hurricane insurance losses. The rest was covered by subsidies, assessments and post-event bond issuance. That’s not sustainable, particularly not in a world where subsidies may be cut, assessments may make insurance unaffordable and post-event bonds may actually be very difficult to sell.

The report from the I.I.I. concludes that there are a number of issues that need addressing as the residual insurance market of last resort becomes more the insurance market of first choice, or even only choice, in some U.S. states. One of the main risks they see is a lack of risk transfer as risks are concentrated on the state itself or on its property owners. A massive hurricane hitting a coastal U.S. state will make this phenomenon evident to all and could result in major issues within the U.S. and global re/insurance market.

The report gives a very detailed overview of the current status of the residual property insurance market in the U.S. but doesn’t offer too many solutions to the problem. Risk based pricing is certainly one issue discussed, along with a lack of true risk transfer among these insurers of last resort.

With close to $900 billion of exposure in this part of the insurance market the reinsurance market alone could not provide the capacity required to cover that amount of risk. In fact the only source of cover large enough might be the capital markets. It is likely that we’ll see continuing insistence from policymakers that insurers of last resort acquire private market risk transfer and some of that is likely to follow the example of Florida and Louisiana Citizens (amongst others) and test out the waters in the catastrophe bond and capital markets.

You can find the details of catastrophe bonds issued by some of these insurers of last resort here:

• Florida Citizens – Everglades Re Ltd. (Series 2012-1)
• Louisiana Citizens – Pelican Re Ltd. (Series 2012-1)
• North Carolina JUA / IUA – Johnston Re Ltd. (Series 2011-1)
• Massachusetts Property Insurance Underwriting Association – Shore Re Ltd.
• North Carolina JUA / IUA – Johnston Re Ltd.
• North Carolina JUA / IUA – Parkton Re Ltd

Access the full report from the I.I.I. here.