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Residual market insurers increasingly use catastrophe bonds: A.M. Best


U.S. residual market insurers, which are often the state-backed non-profit and in extreme cases the insurer of last resort for property coverage, are increasingly relying on catastrophe bonds and the capital markets as sources of reinsurance protection.

A special briefing from rating agency A.M. Best looks at the growing use of catastrophe bonds by these residual market insurance entities. Of course we’ve covered many of these deals on Artemis over the years and this trend is one we expect to accelerate, especially while catastrophe bond rates remain so low.

The most recent residual market insurer catastrophe bond transaction completed on Monday of this week, the $400m Ursa Re Ltd. (Series 2014-1) transaction for the California Earthquake Authority (note, the CEA is not a last resort or residual insurer, rather it is a a not-for-profit, publicly managed-privately funded entity). Glenn Pomeroy, CEO of the CEA, told Artemis that the rise of the capital markets within natural disaster re/insurance was a benefit to his organisation, a view that is no doubt held by the leaders of other residual market or state-backed insurance entities.

A.M. Best says that reinsurance convergence, where capital market investors have become providers of catastrophe reinsurance capacity, has provided an opportunity for these insurers that often act as last-resort providers of property cover to transfer some of their peak risk exposure to the capital markets.

These insurers, such as Fair Access to Insurance Requirements (FAIR) plans, Beach/Windstorm plans and quasi state-run insurance companies, have welcomed the availability of insurance-linked instruments such as catastrophe bonds, industry loss warranties and insurance-linked funds as sources of reinsurance cover.

In the main, these insurers are finding their exposures continually grow due to increasing property values at risk, making the use of instruments such as cat bonds to offload the peak risk increasingly attractive to them.

The growth in exposures of residual market and last-resort insurers has occurred despite some embracing depopulation, A.M. Best notes and the insurance and reinsurance market’s cautious approach to assuming peak wind exposures.

Of course the cautious approach to accepting these risks has become less cautious in recent years, as the high levels of capital in the reinsurance market have seen rates for these peak wind risks in the U.S. plummet. Competition for accessing these risks has also been high, meaning that the growing amount of risk transferred to the catastrophe bond market is a prime target for competitive traditional reinsurance firms.

These entities are able to compare the cost of using cat bonds with traditional reinsurance, which allows them to weigh up the most cost-effective source of capacity to use. This added benefit may actually reduce their overall cost of reinsurance, A.M. Best says, particularly now that insurance-linked fund managers have come to appreciate their own lower-cost capital enabling the cost of catastrophe bond issuance to become more affordable and even in some cases cheaper than comparable traditional products.

A.M. Best has tracked the use of catastrophe bonds by these residual market or last-resort insurers from 2009 through the 30th September 2014. In that time period A.M. Best recorded $5.52 billion of issuance by these entities, with U.S. hurricane risks accounting for $4.47 billion or 81.2% and U.S. earthquake risks the other $1.05 billion or 18.8%.

We can now take that number up to $5.92 billion for total issuance by residual market or last-resort insurers since 2009, with the Ursa Re cat bond from the CEA adding $400m to the total.

The most prevalent sponsor of cat bonds among this group is clearly Florida’s Citizens Property Insurance Corp., with $2.5 billion of cat bond capacity issued since 2009 in just three deals. This includes the $750m Everglades Re Ltd. (Series 2012-1), the $250m Everglades Re Ltd. (Series 2013-1) and the largest single cat bond issue ever, the $1.5 billion Everglades Re Ltd. (Series 2014-1).

Next comes the North Carolina Joint Underwriting Association / Insurance Underwriting Association, with $1.206.84 billion. The deals included are, the $200m Parkton Re Ltd in 2009, $305m Johnston Re Ltd. in 2010, $202m Johnston Re Ltd. (Series 2011-1) and the largest at $500m Tar Heel Re Ltd. (Series 2013-1).

Following that is the California Earthquake Authority, with its $600m of cat bonds issued under the Embarcadero Re transformer. These are the $150m Embarcadero Re Ltd. (Series 2011-1), the $150m Embarcadero Re Ltd. (Series 2012-1) and the $300m Embarcadero Re Ltd. (Series 2012-2). The CEA’s total now stands at $1 billion with the addition of its largest cat bond, the $400m Ursa Re Ltd. (Series 2014-1).

Next we have the California State Compensation Insurance Fund, with its two cat bonds linked to workers compensation losses caused by earthquakes. These two deals total $450m of cat bond risk capital, with $200m from Golden State Re Ltd. (Series 2011-1) and $250m from Golden State Re II Ltd. (Series 2014-1).

Next is the Texas Windstorm Insurance Association (TWIA), with its first and only catastrophe bond that it issued this year, the $400m Alamo Re Ltd. (Series 2014-1).

Louisiana Citizens Property Insurance comes next, with $325m of catastrophe bond risk capital sourced through two transactions, the $125m Pelican Re Ltd. (Series 2012-1) and the $140m Pelican Re Ltd. (Series 2013-1).

The final residual market or last-resort insurer to issue a catastrophe bond since 2009 is the Massachusetts Property Insurance Underwriting Association, which accessed ILS capacity with the $96m Shore Re Ltd. cat bond in 2010.

In terms of catastrophe bond risk capital outstanding, A.M. Best’s numbers show that approximately $3.9 billion of its figure of $21.2 billion outstanding at 30th September, was sponsored by these residual market or last-resort insurance entities. That’s approximately 18% of the total cat bond capacity at risk, based on A.M. Best’s figures.

Reflecting the important role that these insurers play in bringing large amounts of catastrophe risk to the ILS market, these figures on issuance by year and how much of that came from residual market or last-resort insurers show the increasing importance of these deals.

Residual market or last-resort insurer catastrophe bond issuance by year - Source: A.M. Best

Residual market or last-resort insurer catastrophe bond issuance by year – Source: A.M. Best

A.M. Best analysed the risk return profile of these catastrophe bonds, looking  at metrics such as expected loss, spreads and the multiples there of. It concluded that the returns for residual market or last-resort insurer cat bonds have been very healthy; “Given the low-interest environment for fixed-income securities of similar quality and the fact that most P/C-related perils cat bonds are rated non-investment grade.”

“Investors in cat bonds issued by these entities have been rewarded handsomely for the period under consideration. So far, none of the cat bonds issued by these entities have triggered,” continued A.M. Best.

A.M. Best explains the importance of having access to the capital markets for these insurers:

Given an estimate of nearly USD 758 billion of exposure to loss for FAIR and Beach/Windstorm plans as of 2010, according to the Insurance Information Institute, a major hurricane event will impact insurance claims and pricing, and also create capacity issues and financial difficulties for these entities. In addition to assessment of levies, traditional reinsurance and other funding mechanisms before or after a catastrophe loss event, the capital markets provide another viable vehicle for these entities to cede hurricane/wind risk.

The growing availability and proliferation of insurance-linked securities (ILS) and collateralized reinsurance instruments, including catastrophe bonds, insurance-linked instruments and insurance-linked funds, adds another dimension to the protection available to these insurers. This allows them to increasingly diversify and better manager their catastrophe exposures, demonstrating the importance of the convergence trend.

Finally, A.M. Best notes that other areas of residual market, state-backed or last-resort insurance that could eventually tap the capital markets, through catastrophe bonds or other instruments, include flood insurance risk, assigned risk non-property plans facing capacity issues such as workers compensation, auto, accident/health, or terrorism risk exposures.

It is expected that the volume of risk transferred to the capital markets just by these main residual market sponsors of cat bonds will increase in the coming years. Catastrophe bonds and the capital markets provide a low-cost source of efficient reinsurance capacity that both residual market and last-resort insurers are increasingly keen to transfer their risks to.

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