Florida Cat Fund looks to cat bonds & collateralized reinsurance

At an insurance summit held yesterday in Orlando, Jack Nicholson the COO of the Florida Hurricane Catastrophe Fund said that it is seeking approval to buy up to $1.5 billion of private reinsurance, and favors using catastrophe bonds and collateralized reinsurance.

The subject of the Florida Hurricane Catastrophe Fund, how it is funded and how it finances risk transfer, is a regular topic of conversation both in Florida and in the wider global reinsurance community. The reinsurance market would like to take on more of the job of reinsuring the Fund and the U.S. government would also like to reduce the reliance on taxpayer-backed funding.

At the event, Florida Hurricane Catastrophe Fund COO Jack Nicholson, discussed the need to reduce the cat funds use of private debt issuance and bonding, due to the volatility in financial markets and that private reinsurance is now on the table as a real option in 2014 to increase the funds risk transfer.

Nicholson said that as the state of Florida grows, exposure in the state grows and the Catastrophe Fund becomes more risky as a financing mechanism. This has pushed the Catastrophe Fund to look to the private traditional and alternative or insurance-linked securities (ILS) markets as potential sources of risk capital.

The cat fund needs to be able to meet its claims paying responsibilities in the event of multiple hurricanes hitting the state, but financial market volatility means this is not as guaranteed as it was thought to be in previous years.

Nicholson said that the cat fund’s operation all starts with the ability to pay claims. The cat fund does look at risk transfer options and this is one option for helping the state to get the cat fund down to a better size.

The current reinsurance market dynamic, of a well-capitalised traditional reinsurance market and a growing alternative reinsurance capital and ILS market, provides the Florida cat fund with a unique opportunity. Reinsurance pricing is approaching record lows, particularly for ILS backed capacity, meaning that this is possibly the best opportunity the cat fund has had to increase its risk transfer using private market sources.

The terms and conditions of collateralized reinsurance and catastrophe bonds can be a little more restrictive, said Nicholson. But if structured to protect the right layer within the cat fund and with the right trigger these alternative reinsurance capital solutions may be attractive.

With the level of competition in the reinsurance market having increased with the growth of alternative reinsurance capital, the terms and conditions available have become more flexible and now the Florida cat fund feels it may be able to secure a product that meets its needs.

Nicholson discussed the need to look at private reinsurance and alternative solutions, for a product that fits above the cat funds cash balance, so avoiding bonding as much as possible. Any risk transfer purchase would also need to have terms and conditions that are the same as those the cat fund has governing how it pays insurers. So a reinsurance or collateralized protection which has no holes in it, explained Nicholson.

Nicholson said that the cat fund has decided to go forwards with a private reinsurance purchase for 2014, subject to the necessary approvals from its board and the state government. He said that the time is right as pricing is reasonable, the impact on cat fund rates would be reasonable and the impact on consumers would also be reasonable.

Nicholson said that the cat fund will look to buy up to $1.5 billion of reinsurance protection, as long as it is at a specified price that the cat fund believes is reasonable. A multi-year coverage is most attractive to the cat fund, said Nicholson, particularly if the layer of protection can be moved up or down if losses do or do not occur. That kind of flexibility is what the cat fund is particularly interested in and seems ideal for coverage with a catastrophe bond or other collateralized reinsurance structure.

Nicholson said that the options available to the cat fund are catastrophe bonds, collateralized reinsurance and traditional reinsurance. The cat fund will look at whatever solutions best fit its needs, with respect to price, coverage and terms and conditions, he said, adding that collateralized reinsurance is particularly attractive due to its simplicity but that cat bonds are definitely an option on the table.

Nicholson said that the cat fund has three brokers, Aon Benfield, Guy Carpenter and USRE, all lined up and waiting to take its needs for up to $1.5 billion of cover to the private reinsurance market if approval is given by the Florida Cabinet. In terms of timing Nicholson said as soon as possible, but realistically he hoped the initiative would be heard by the Cabinet by March.

For many years the private reinsurance market has wanted to participate in providing risk transfer for the Florida Hurricane Catastrophe Fund and it looks like 2014 will be the year that it gets its chance. With reinsurers and ILS specialists all looking for more risk, particularly in peak zones such as Florida, the competition for providing this reinsurance protection is likely to be high.

It will be interesting to see whether the capital markets provides some or even all of this protection for the cat fund. The capacity could likely be secured if the cat fund chose to place the entire $1.5 billion through a mix of catastrophe bonds and collateralized reinsurance and would be welcomed by investors.

Of course traditional reinsurers would also like to get their hands on this reinsurance program and are likely to compete strongly, perhaps offering even more improved terms and conditions to attract the cat fund to their form of risk capital.

However the Florida Hurricane Catastrophe Fund decides to secure its reinsurance protection, the fact that it is looking to the private market for cover is ground breaking and brings a significant chunk of new capacity into play. That will ultimately be welcomed by both traditional reinsurance and ILS capital players alike.