Swiss Re takes weather derivative loss & New Zealand loss creep in Q1

Global reinsurance firm Swiss Re’s first-quarter 2016 results were impacted by weather derivative losses and further adverse development from the New Zealand earthquakes, which could signal impacts more broadly, perhaps affecting some insurance-linked securities (ILS) players.

With Swiss Re among the largest insurance and reinsurance companies in the world, what impacts its bottom line also has the potential to affect more reinsurance firms and also ILS fund managers, given their growing exposure to global events.

The two events in question have both impacted Swiss Re during Q1, but it doesn’t necessarily mean others will book or account for the effects in the same period.

Swiss Re’s corporate insurance book was impacted by the continuation of an “unseasonably mild winter”, the reinsurer said, acknowledging that its Corporate Solutions unit was hit by “realised losses from insurance in derivative form.”

The weather derivative losses, or insurance in derivative form as Swiss Re terms it, resulted in net realised losses of $13 million in Q1 2016, compared to gains of $38m in Q1 2015.

Making bets on the weather in this way with weather derivatives is challenging, as seasonal forecasts can often be proved wrong by the time the covered risk period comes around. The globe has seen record average temperatures each month through this recent winter, which has made a weather derivative or insurance policy very attractive to energy providers and resulted in some fairly large collections by a number of gas suppliers.

These companies buy weather risk protection to cover them against winters being milder than expected, as their customers use less energy for heating, or summers being cooler than forecast, as energy use for air conditioning can drop dramatically.

Weather derivatives, in their most vanilla form of heating and cooling degree days or average temperature based, can be volatile instruments and with the record warm winter temperatures Swiss Re has suffered this year.

There are a number of ILS fund managers who operate in the weather derivative space, so there is the potential for this Swiss Re loss to signal a loss at other providers of weather risk transfer capacity. Other reinsurers or insurers who also underwrite weather risks on a temperature basis will also likely be exposed to some impact from this winters unusually mild weather.

The other announcement in Swiss Re’s Q1 2016 results that could have ramifications for more of the market and potentially some ILS players, is the announcement that it has been impacted by adverse development of its New Zealand earthquake losses during the quarter as well.

Interestingly, Swiss Re notes that a year earlier it had made reserve releases for this loss, but as the complexity of the claims scenario associated with the Christchurch, New Zealand earthquakes continues the reinsurer has decided to add to its reserves this year.

That means Swiss Re has been notified by a counterparty, or number of counterparties, that claims totals continue to rise for the New Zealand quakes.

David Cole, Swiss Re CFO, noted; “We react quickly to claims development in order to remain well reserved on a best estimate basis.”

Swiss Re did not give any idea of the size of this adverse development from the New Zealand quakes, but, like the weather derivatives loss, given Swiss Re’s scale and position in the global reinsurance market it stands to reason that adverse development for the company will likely signal further worsening of positions for some other reinsurance companies and potentially any ILS or third-party capital backed exposure to New Zealand that remains.

The majority of ILS fund positions related to the New Zealand earthquakes were shut down or commuted a few years ago, as ILS managers sought to settle any claims as quickly as possible to avoid collateral being locked for long periods of time.

That could have proved to be a very smart move, as the claims development seems to be continuing from the event. Insurer IAG reported further worsening of its New Zealand earthquake exposure last year, confirming the size of the exposure late in the year.

It’s unlikely that Swiss Re’s reserve hardening for the New Zealand earthquake is due to IAG’s exposure, as the Australian insurer said it had burned through all of its reinsurance for that event already. That suggests that this is due to another counterparty, which does raise the possibility of other reinsurers finding themselves exposed.

Once again, the adverse development of New Zealand quake exposures highlights the complexity associated with earthquake losses and raises the issue that quake is perhaps not the short-tail catastrophe peril that some underwriters believe it to be.

Swiss Re’s experience with these two acknowledged losses, the weather derivatives loss and continued New Zealand earthquake loss creep, again highlight the need for ILS funds and investors to reserve prudently and ensure reserving practices are focused on minimising collateral lock-up.

Any specific impact from similar weather-related losses or New Zealand exposure for ILS funds would be expected to be minimal, but there is certainly a chance some funds carry positions that are at risk, particularly on the weather derivative side.