Hurricane Matthew to test collateral mechanisms: Doucette, Everest Re

by Artemis on October 26, 2016

The impact of hurricane Matthew and the insurance and reinsurance industry losses the hurricane caused when it struck the Florida and Southeast U.S. coastline could “test the functioning of various collateral mechanisms,” according to John Doucette of Everest Re.

Hurricane Matthew raked the Florida, Georgia, South & North Carolina coastline just a few weeks ago, after having cut a path of destruction through the Caribbean. Currently insurance and reinsurance industry loss estimates suggest an impact in the mid to high single-digit billions of dollars, but even at this level there is the potential for the structures of fully-collateralized reinsurance products to be tested.

Bermuda-headquartered reinsurer Everest Re reported its results yesterday and gave some clarity on where it sees the loss sitting and the impact to itself, suggesting that a $3 billion to $9 billion industry loss range could hit the reinsurer for between $75m to $200m of losses.

But Everest Re has its own fully-collateralized reinsurance vehicle, the Mt. Logan Re sidecar style special purpose insurer, which deploys third-party investor capital alongside Everest’s own balance-sheet.

Speaking during the firms third-quarter 2016 earnings call, President and CEO of Reinsurance at Everest Re John Doucette said that hurricane Matthew may provide a test for the insurance-linked securities (ILS) and collateralized reinsurance market.

“Recently, the reinsurance industry was confronted with its first significant Florida wind loss in over a decade, but Matthew will be a lesser impact to the industry than initially feared,” Doucette explained.

In fact for Everest Re Doucette feels Matthew losses are entirely manageable, explaining; “Nonetheless, we are comfortable that our exposures are well-controlled, given the gross portfolio we have built, as well as the various mitigation tactics we employ. Additionally, our global diversification across various lines of insurance and reinsurance buffers the group loss to such events, making them manageable.”

But one area hurricane Matthew may provide a test of, not in terms of capital and the ability to pay claims, but rather in the functioning of the market structures and mechanisms that have been developed, is in collateralized products, Doucette suggested.

“Although Matthew will not be a game-changing loss for most collateralized or traditional players, it may test the functioning of various collateral mechanisms,” he commented.

“As a buyer of both traditional and collateralized reinsurance, we are familiar with the complications and potential headaches of collateralized [arrangements],” Doucette continued. “These complications compound with uncertainty around the ultimate outcome of a large event such as Matthew, given new cedents and untested claims management processes.”

It’s a valid point as there are potential issues and difficulties that could arise for some ILS funds due to hurricane Matthew, if the storm was to result in locked up collateral for a prolonged period.

Locking up collateral, due to a drawn out wait for an industry loss to be released, or complications in claims calculation at cedents after an event, could effectively shrink available collateral for some ILS players.

Granted, the larger ILS fund managers likely have contingency plans and are typically prepared to settle as early as possible in order to ensure collateral is freed up in prompt time. Also the larger ILS fund managers have ample experience of dealing with claims and hurricane Matthew is nothing unexpected in terms of magnitude of loss.

But smaller ILS funds or collateralized reinsurance vehicles, perhaps with less experience, could find their collateral still trapped as the key January renewal approaches fast, which would be a less than desirable outcome.

There’s also some potential for aggregate contracts to get close to attachment points in 2016, with a number of losses hitting ILS players so far. If that happens the collateral could potentially be trapped while a ceding company waits for full clarification of its exposure under the terms of an aggregate reinsurance arrangement.

That’s an extreme case though, as hurricane Matthew does not look like a particularly complex loss, nor is it that sizeable. But it will test the collateral mechanisms in the ILS market, how ILS managers deal with claims and how investors deal with any lock-up.

Doucette went on to explain that because of the way Mt. Logan Re is structured, cedents that benefit from its collateralized reinsurance cover do not have to worry about such things.

He explained; “While Mt. Logan provides significant, collateralized support, ultimately serving our clients, it stands behind Everest and is invisible to our cedents, unburdening them from the inherent complexity of such arrangements.”

Of course that’s not to say that Everest Re would pay out claims using its own capital in every case, but for a loss like hurricane Matthew we’d imagine that Everest can deal with claims on behalf of Mt. Logan to a degree.

Were the industry to face a $100 billion hurricane loss it would be a different story though and we’d imagine that Everest Re would have to deal with the testing of its own collateral mechanisms in Mt. Logan Re just like any other manager of a third-party capital vehicle, at least for a period of time. It’s unlikely that sitting behind the sponsoring reinsurer would make the vehicle immune to this in every case.

In the case of a really significant loss Everest Re would also be looking to claim on its outstanding Kilimanjaro Re catastrophe bonds as well and would be hoping for a swift payout we’re sure.

The real story with hurricane Matthew and a number of other losses this year is that the ILS market and its collateralized reinsurance mechanisms is being well-tested in 2016.

Perhaps not by the massive, industry changing loss that some would like to see test the ILS market, but the attrition of multiple events is also set to test aggregate coverage as well as per-occurrence, which is a valuable learning experience for managers of capital market-backed reinsurance vehicles.

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