Hurricane Patricia highlights role for ILS on peak exposures: Karen Clark

If a storm as intense as hurricane Patricia struck downtown Miami, Florida, insured losses could reach $200 billion, according to Karen Clark & Company (KCC), highlighting a growing need for insurance-linked securities (ILS) to supplement traditional reinsurance for peak U.S. exposures.

Hurricane Patricia was one of the strongest storms ever recorded, but owing to a fortunate path through parts of Mexico it avoided many highly populated areas and as a result insurance and reinsurance losses are expected to be relatively low.

However, should a storm of similar intensity, power and scale hit downtown Miami, Florida, a region where 14% of all landfalling U.S. hurricanes occur, total losses would likely exceed $300 billion, and insurance and reinsurance losses could surpass $200 billion.

Furthermore, according to KCC 30% of all Category 4 and 5 storms that have happened in the U.S. have occurred in southeast Florida.

“It’s only a matter of time before there’s a mega-loss from a hurricane in the U.S., and it’s vital for the industry, including regulators, to monitor risk metrics other than PMLs.

“The losses from a hurricane like Patricia in certain locations will far exceed PMLs and traditional reinsurance protections and will put many insurers out of business,” said Karen Clark, Co-founder and Chief Executive Officer (CEO) of KCC.

The reality is that insured losses in the $200 billion range, in certain locations, would almost certainly cripple many insurers in the region. As typically their traditional reinsurance coverage isn’t adequate for losses of this magnitude, or events of this rarity, underlining the opportunity and need for greater ILS market participation.

Clark highlights this point; “For most insurers, traditional reinsurance does not cover their peak exposures, and the ILS market could add more efficient capacity.”

Furthermore, explains Clark; “A traditional cat treaty is not an efficient form of protection for extreme event losses because most insurers have just a few areas of exposure accumulation where an event like Patricia in one of those areas would cause a solvency-impairing loss.”

The use of ILS structures and their efficient capital, including catastrophe bonds, sidecars and similar, are well suited to protecting against peak U.S. exposures, underlined by their ability to tailor individual transactions for specific needs.

“A parametric-trigger type cat bond could be better suited for peak exposure covers – particularly one tailored specifically to an insurer’s exposures such as Compass Re II,” says Clark.

Interestingly, and further highlighting the benefits of utilising ILS protection for peak exposures, and in particular a parametric-trigger type cat bond, hurricane Patricia’s intensity and course has exposed a $100 million tranche of notes from the MultiCat Mexico Ltd. (Series 2012-1) Class C catastrophe bond.

For exposures of this magnitude, with the potential to incur losses in the hundreds of billions it’s essential that insurers and reinsurers are adequately capitalised and protected.

Despite events like hurricane Patricia being rare, and the fact there hasn’t been a major Florida landfalling storm for a decade, the threat is still very real, and companies need to be prepared for the worst to avoid being wiped out post-event.

The significant potential economic and insured losses reported by KCC in its study, ‘What Happens When a Hurricane Strikes the U.S.,’ underline the need for robust insurance and reinsurance coverage, supplemented and bolstered by the capacity, willingness and ability of the ILS market, its participants and structures.

Emphasising the reality that a mega-storm making landfall along the U.S. coast is likely to happen at some point in the future, and that individuals, insurers and reinsurers need to be prepared, the report concludes; “Patricia broke the record for maximum sustained wind speed, but several other storms have been close to Patricia in terms of wind intensity and minimum central pressure.

“Therefore, Patricia should not be thought of as an outlier, but rather as an example of the type of extreme event that could easily happen again.”