‘Reinsurance, capital markets reluctant to take on terrorism risk’

So says the U.S. President’s Working Group on Financial Markets (PWG), in a recent report to Congress looking into the long-term availability and affordability of terrorism risk insurance which was published last Thursday.

The PWG is mandated under the Terrorism Risk Insurance Act (TRIA) to analyse and report on the availability and affordability of terrorism insurance. Naturally these reports take into consideration the changing reinsurance market and the supply of reinsurance capital, including that growing segment sourced from the capital markets.

The latest report, published on Thursday, comes just after the introduction of a bill by a bipartisan group of senators which looks to extend TRIA by seven years while raising the contribution to losses paid for by insurers.  The PWG’s report agrees that insurers need to take on more of the burden for terrorism losses, but warns that the reinsurance and capital markets may not be prepared to shoulder too much of the burden.

So while it looks increasingly likely that TRIA will be extended, although it’s not yet guaranteed, it does not look like a significant amount of the risk will be pushed into the private reinsurance market. The PWG report says that the private market does not have the capacity to provide terrorism risk reinsurance to the extent currently provided by TRIA and that without TRIA the availability of terrorism insurance would be limited and it would be more costly.

The need for a federal backstop for U.S. terrorism insurance to exist is not in doubt, the majority of the reinsurance market or capital markets participants in reinsurance would certainly agree. With the modelled losses from extreme terror events stretching into the many hundreds of billions of dollars, the availability of insurance to cover terror risk is certainly helped by TRIA being in place.

However the PWG said in the conclusion of its report that; “Reinsurers and the capital markets appear reluctant to provide further support to the terrorism risk insurance market.”

This statement just does not appear accurate in the light of comments made by reinsurance and insurance-linked securities (ILS) market participants. While nobody has said that they’d like to see government protection for terrorism risk disappear completely, many market participants have said that they feel capable of taking on more of the responsibility for terrorism reinsurance that TRIA currently provides.

In fact some reinsurance capacity from third-party capital market investors is already being deployed into terrorism risks, one example being Swiss-based ILS manager Twelve Capital which said earlier this year that it generated attractive returns from transactions exposed to global terrorism.

Another example would be Lancashire Holdings third-party reinsurance capital management unit Kinesis Capital Management is another which includes some terror risk within its third-party capital backed underwriting.

Reinsurers have also expressed a desire to take on more terrorism risks. Validus Holdings CEO Ed Noonan said last year that he sees no reason for terror risks to be backed by the government and that the reinsurance industry should be pushing to obtain more of this business.

Likewise, Kevin O’Donnell, CEO and President of RennaissanceRe, said that his firm has the ability to write terror risk, and has done so over the years, so if demand for terrorism risk reinsurance increases he also feels the capacity will be available to support it.

Another proponent of the capital markets desire to participate in underwriting a portion of the terrorism risk assumed under TRIA is specialist ILS investment manager Fermat Capital’s co-founder and managing principal John Seo. Seo even spoke to lawmakers about this, in a testimony to the U.S. House of Representatives, where he said that the ILS market had a growing ability to take on risks such as terrorism.

Seo said that an expanded ILS, catastrophe bond and alternative reinsurance capital market could make as much as $9 billion to $12 billion of third-party reinsurance and ILS capacity available to terrorism risks in the future.

Finally, and most recently, rating agency Standard & Poor’s said that it anticipates some alternative reinsurance capital being allocated to terrorism risk in the future, although it expects the role of ILS and alternative capital in terrorism reinsurance to remain a minor one.

So, to say that reinsurers and the capital markets ‘appear reluctant’ to provide additional support to the terrorism risk insurance market is not strictly accurate. In fact, with the decline in reinsurance pricing and the softening market impacting most reinsurers and pushing them to look for new sources of business, as well as the appetite of the capital markets to access more insurance linked investments, the PWG may be surprised. If more terrorism risk opportunities became available to the private reinsurance and ILS market it is likely that there would be at least some players keen to support them.

The private reinsurance and capital markets would not want TRIA to disappear entirely. The protection it provides for nuclear, chemical, biological and radiological terror risks is an area that the reinsurance market prefers to stay away from. Also the potential losses from a threat of those kinds would exceed the reinsurance market’s capitalisation, modelled losses for a nuclear or dirty bomb in New York for example are in the many hundreds of billions of dollars.

In a report published this week by broker Marsh, in which it surveyed insurers on their use of terror insurance coverage, it discusses the need for the TRIA backstop to be renewed.

“We believe TRIA is a model public-private partnership. Marsh’s new report confirms there is strong, long-term demand for the insurance it backstops with more than six out of 10 companies in the survey purchasing coverage,” said Dan Glaser, President and CEO of Marsh & McLennan Companies. “The existence of the federal program plays a major part in the availability and affordability of the coverage.”

“The recent introduction of a bi-partisan bill to reauthorize TRIPRA is an encouraging step in the right direction,” said Duncan Ellis, Marsh’s US Property Practice leader. “Everyday clients are calling us with concerns over market volatility and pricing. We look forward to the reauthorization of this important federal backstop for another seven years and working with clients to ensure they have the right coverage to protect their assets.”

Marsh’s report makes it clear that no private insurance or reinsurance market is currently large enough to pool the risks of unconventional or large-scale terrorism losses. That said, there is currently only around $6 billion to $8 billion of private market reinsurance available for terror risks, which does seem like a fairly small number given the exposure.

A presentation given by Marsh staff showed a telling slide which compares U.S. insurance industry expected losses for property and workers compensation from hurricanes, earthquakes and terrorism. As you can see from the chart below terrorism risks could result in a considerably larger loss than hurricanes or earthquakes at the same return periods.

U.S. insurance industry losses, property and workers compensation – Source: Marsh

Marsh says that the continued uncertainty around the extension of TRIA has affected the price and availability of terrorism insurance cover, just what the PWG warns of in its report as well.

However, Marsh also disagrees with the PWG’s assumption that the reinsurance and capital markets are reluctant to take on more terrorism risk. Marsh notes that since the influx of alternative capital into reinsurance from third-party investors such as pension funds, traditional reinsurers have been seeking new opportunities and are possibly more supportive of terrorism risk as a result.

But nontraditional or alternative reinsurance capital has not yet widely deployed into the terrorism risk market, Marsh says. “This appears to be because of less confidence in the probability component of terrorism models, the tail risk/payout patterns for workers’ compensation, and the possible correlation of a downturn in the equity/investment market to a large-scale terrorism event,” Marsh’s report says.

With the support of the government to provide TRIA type cover, where the reinsurance and capital markets cannot step in, the private markets could and very likely would increase their participation. Support would also be needed to ensure that the private markets supported the risks that they were comfortable modelling, while the government takes on those which sit outside of the private market currently.

Marsh agrees, saying; “It is expected that the alternative nontraditional reinsurance market will be addressing these challenges and will likely offer additional terrorism capacity in the future.”

The new TRIA bill that has been proposed will increase insurers share of losses and may be a first step in spreading more of the terrorism risk into private reinsurance markets. However it perhaps does not go far enough when there is clear evidence that further work on involving both the reinsurance and capital markets in terrorism risk reinsurance is required.

Read some of our previous articles on this topic:

– S&P: Alternative reinsurance capital anticipated in terrorism risk.

– Experts forecast a bigger role for ILS in terrorism insurance.

– Is it time the capital markets helped out with terrorism risk transfer and reinsurance?