Florida Cat Fund to seek $1B reinsurance or collateralized (no cat bonds)

by Artemis on April 14, 2015

The Florida Hurricane Catastrophe Fund (FHCF) is getting closer to accessing the private reinsurance and risk transfer markets for the first time, as it seeks to better protect itself and take advantage of near-record low reinsurance rates for Florida property catastrophe risks.

Update: The proposal detailed below was approved at the Cabinet meeting.

The FHCF was approved to pursue up to $2.2 billion of protection through a combination of risk transfer, so private market traditional reinsurance, collateralized reinsurance coverages and/or catastrophe bonds, alongside pre-event bonding.

Now, the FHCF has narrowed down its requirements and later today will seek approval from the Cabinet and Florida Governor Rick Scott to seek $1 billion of reinsurance protection, with the remaining $1.2 billion to be secured through pre-event bonds, according to the proposal.

According to FHCF CEO Jack Nicholson the reinsurance will not include a catastrophe bond in 2015. For this $1 billion layer of cover the FHCF is only considering a combination of traditional reinsurance and other collateralized reinsurance solutions. The ultimate mix will be dependent on the pricing and attractiveness of the different options that are available.

Nicholson told Artemis that catastrophe bonds are not in the mix for 2015, but may be considered in the future. He said it was unlikely for this year as there is a lot that the FHCF will need to learn about cat bonds given its coverage needs.

Reinsurance broker Aon Benfield has been signed up to secure the reinsurance protection for the Florida Hurricane Catastrophe Fund (FHCF), so if the Cabinet meeting later today approves the FHCF’s recommendation the work to secure the $1 billion of cover will begin immediately.

Securing the $2.2 billion of additional protection, through $1 billion of reinsurance (traditional or collateralized) and the $1.2 billion of pre-event bonding, would enable the FHCF to reach its $17 billion statutory maximum obligation to reimburse its participating insurers.

As the risk transfer and reinsurance markets are about as conducive and well-priced as they have ever been for the type of risk the FHCF is looking to transfer and based on analysis undertaken by Aon Benfield and the FHCF, it has been decided that targeting $1 billion of reinsurance cover at a rate-on-line of 6.78% or below is optimal for its needs, alongside the $1.2 billion of pre-event bonding.

The estimated premium for the $1 billion of reinsurance protection is reported to be $67.8m or less, according to the FHCF. As a result of the costs of the reinsurance risk transfer and the pre-event bonding the impact on residential premiums is expected to be minimal at under 1%. In fact, the true cost as the better protection will eliminate emergency assessment premiums going forwards is actually expected to reflect a decrease, which should please doubters of this strategy.

In the past the market pricing available for reinsurance cover has not been low enough for the FHCF to be able to consider it properly. In 2015 this has clearly changed and the FHCF is now better positioned to take advantage of attractive pricing.

As the FHCF has built up significant cash after a number of benign hurricane seasons and reinsurance and risk transfer pricing is so attractive, it can now target reinsurance at such a level of attachment that the cost is aligned with its needs. Also the improved terms and conditions of reinsurance also has made reinsurance a more conducive option to the fund.

The reinsurance cover will likely be at an attachment level of $12.5 billion of claims or above, which the FHCF says will result in an attachment probability of around 3.63% to 4.49%, depending on the estimation model used.

Aon Benfield estimated that the cost of buying $1 billion of reinsurance protection would be 6.78% rate-on-line, but after anticipated coverage shifts this could actually come out as low as 6.38%.

Aon Benfield said that based on a Sharpe Ratio to compare pricing, $1 billion of reinsurance cover would provide the best value. It said that the Sharpe Ratio for this would be 22.78%, with lower signaling better pricing as it implies a lower premium paid for the risk transferred. By comparison Aon Benfield said that recent catastrophe bond transactions implied a 30% Sharpe Ratio.

The FHCF says that this implies that property catastrophe reinsurance pricing is trending to historic lows. This likely added to the decision that cat bonds will not feature in the $1 billion purchase at this time.

The multi-year nature of catastrophe bonds may make it conducive to have at least a portion of the coverage in cat bond form in the future though, as that may secure a low rate-on-line over perhaps as much as a five-year period for the FHCF. With cat bond rates at or near lows right now it would seem prudent for this to be considered within the reinsurance purchase, which it seems the FHCF has. As the fund learns more about the cat bond market we’d imagine the renewal next year may see them feature.

The State Board of Administration, which administers the FHCF, will recommend the combination of $1 billion of reinsurance and $1.2 billion of pre-event bonding to the Cabinet today. It explains:

By combining reinsurance with pre-event debt, the FHCF will be able to better manage its risk at a very reasonable cost, thus providing true risk transfer for the first $1 billion in excess of the fund’s cash balance, and maintaining full funding for its statutory liability in subsequent seasons in the event there are no storms in 2015. For these reasons, we recommend the combined approach of $1 billion of reinsurance and $1.2 billion of pre-event debt financing.

The reinsurance component should be at a total rate-on-line not exceeding 6.78%. The FHCF believes:

Locking in the cost of these alternatives now eliminates uncertainty regarding the cost of these alternatives in the future and provides additional flexibility for the FHCF in meeting its reimbursement obligations in the future.

We’ll update you as more information becomes available on the decision taken today regarding this proposal and what, in the way of reinsurance protection, is eventually purchased by the FHCF.

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