Growing number of capital markets investors accepting hurricane risk: Fitch

As the insurance and reinsurance industry fast approaches the 2013 Atlantic Hurricane Season, which technically begins tomorrow on the 1st June, ratings agency Fitch Ratings says that the U.S. insurance industry has the capacity to withstand potential losses from hurricane related perils, helped by the growing acceptance of hurricane risk by investors in the capital markets.

Fitch says that the insurance and reinsurance markets have enough capacity to provide sufficient coverage and to be able to withstand potential losses from any hurricane landfalls in 2013. Forecasts for the 2013 hurricane season have all pointed towards an above average season in terms of activity, intensity and landfalling storms, you can see the forecasts on our dedicated page for the 2013 Atlantic Hurricane Season.

Insurance pricing on hurricane exposed property business in the U.S. has generally risen since last years hurricane Sandy, says Fitch. The losses from Sandy, and also Isaac last year, have caused positive price movements in the primary U.S. property insurance market, specifically in regions and lines of business with significant catastrophe exposures.

Conversely though, Fitch note the trend we’ve been writing about, where catastrophe reinsurance pricing, particularly in the higher profile and priced Florida cat market, has been dampened by abundant traditional reinsurance capacity, growing third-party reinsurance capacity and increasing competition from alternative reinsurance products such as catastrophe bonds.

We wrote about the positive price movements in primary insurance lines, and how that has been helping to offset some reinsurance price declines for some, earlier this week here.

Fitch says that the capital markets remain a “Strong and growing presence in the market for underwriting and offering protection from catastrophe risks.” A combination of the continued low-interest rate environment alongside the desire of insurers and reinsurers to utilize alternative means of risk transfer and third-party capital sources, has generated significant growth in new capital in the space.

This is leading to a sea-change in the risk transfer landscape, particularly in Florida, as insurers of high-risk property business look to test out new ways to access capacity and are attracted by the reduced rates on offer from the alternative reinsurance market.

Historically, Fitch says, some of the most hurricane prone regions of the U.S. Atlantic coastline have seen re/insurers try to scale back the amount of risk capital they have exposed to the region. The alternative markets however, driven by capital market investor sourced third-party reinsurance capacity, have found an appetite for this risk and are becoming increasingly accepting of it.

Investors in the capital markets are becoming increasingly sophisticated and able to comprehend and assess the riskiness of deploying capital into hurricane insurance and reinsurance deals. As their understanding of catastrophe risk increases these investors are becoming more willing to accept an elevated level of risk.

Catastrophe bonds and collateralized sources of reinsurance protection are the most prominent instruments that see capital market investors participating in providing sources of alternative catastrophe risk transfer. These instruments continue to grow in popularity, according to Fitch, as has been evidenced by the brisk catastrophe bond issuance seen so far in 2013.

Fitch has counted nearly $2.5 billion of catastrophe bonds issued this year covering U.S. hurricane risks, with varying levels of attachment and types of trigger. Fitch’s number here includes multi-peril cat bond limit. We would put a much higher figure on this now, as our Deal Directory contains $2.844 billion of catastrophe bond limit with exposure to U.S. wind or hurricane issued in 2013 (some of which has yet to complete). The point here is that whatever way you look at it, U.S. hurricane risk is an extremely important part of the cat bond market and as a peril is becoming increasingly accepted by capital markets investors.

Fitch says that it sees the pendulum swinging in favour of catastrophe bond issuers. Those issuers that have managed to reduce issuance costs and are regular participants in the cat bond market are likely to see the biggest advantage and are best positioned to access increasing amounts of capital markets provided capacity at reduced risk spreads and with favourable terms and conditions.

Fitch says that it also maintains a generally favourable opinion of the collateralized reinsurance and risk transfer market as a mechanism for managing hurricane exposed underwriting risk. Fitch notes that collateralized reinsurance capacity has “Afforded sponsors the ability to opportunistically provide additional capacity without straining the company’s capital or increasing aggregate catastrophe exposures beyond tolerances.”

Fitch notes that alternative and third-party reinsurance capacity has impacted rates in Florida for catastrophe risk, with the suggestion that rates could be down 5% to 15% in 2013 due to the growing influence and participation of the capital markets and third-party capital in this market.

Fitch believes it would take a series of major hurricane events this year for it to apply a negative outlook to the U.S. P&C insurance sector. A repeat of hurricane Katrina would only cause the sector to lose around 8% of the industry surplus it had at the end of 2012, and Fitch believes it would need to lose 15% or more of its aggregate surplus for it to consider a sector outlook movement to negative.

So the U.S. P&C insurance sector as well as the global reinsurance sector are both extremely well positioned to withstand a severe hurricane and tropical storm season. It will be interesting to see not just how the traditional re/insurance sectors react to any major storms this year, but also how the capital market investors react to any losses that the hurricane season may threaten.

The 2013 Atlantic Hurricane Season begins tomorrow and runs for six months until the end of November. We’ll keep you updated on any major storms, as they happen, which could threaten losses to the reinsurance and catastrophe bond markets.