The Texas Windstorm Insurance Association (TWIA) has once again been considering the use of catastrophe bonds as part of its reinsurance and risk transfer arrangements in 2013. TWIA is an insurer of last resort which provides windstorm and hail insurance to Texas Gulf Coast property owners who might otherwise be left uninsured. It’s not the first time this insurer has looked at cat bonds as part of its reinsurance, having rejected their use due to cost in 2012.
Today, the TWIA actuarial and underwriting committee met to discuss a number of issues related to its funding and risk transfer. On the agenda were pre-event funding through bond issuances and also post-event protection through reinsurance and risk transfer. The aim of these committee meetings is to come up with proposals to present to the TWIA Board, for us what’s interesting is the role that catastrophe bonds and the collateralized reinsurance markets are playing in TWIA’s meetings on an increasingly regular basis.
One of the agenda items was to review Texas Public Finance Authority recommended options for securing $500m of bond or securitized funding for TWIA. For 2013 one of the options that was on the table was a $500m catastrophe bond, proposed by Citigroup. However TWIA are looking for a solution which improves its claims paying capacity level, not a risk transfer solution, for this area of its funding.
The Citigroup proposal for a huge cat bond with a very low attachment point of $180m to fund TWIA’s immediate claims paying ability was not what the TWIA committee were looking for in terms of this layer of the associations funding. The Citigroup proposed cat bond comes with indicative pricing in the 17% to 20% range which is inline with such a low attachment point and this also received luke warm reception.
On this point in the agenda, the actuarial and underwriting committee of TWIA recommended to the Board a proposal by Bank of America Merrill Lynch for a Bond Anticipation Note of $500m which would allow for Class 1 pre-event bonds to be issued for funding purposes. The large catastrophe bond suggested by Citigroup was deemed as not suitable to this part of TWIA’s overall funding needs, however it is perhaps healthy for the association to begin thinking of risk transfers potential to assist in its wider funding needs.
The next discussion was on TWIA’s reinsurance needs for 2013, closely tied to the above discussion of financing for capacity purposes, but TWIA clearly differentiates between claims paying capacity and risk transfer capacity. That’s a differentiation that for some insurers is not so clear anymore, but being a State property insurer of last-resort TWIA have to consider its capacity needs slightly differently. As we said above though, beginning to think of how risk transfer instruments such as cat bonds could contribute to overall funding is an important step for TWIA.
Catastrophe bonds were raised in the discussion on TWIA’s reinsurance needs for the 2013 hurricane season as well. Reinsurance broker Guy Carpenter, often present at these meetings as TWIA’s key broker, discussed the current market environment, stressing the currently attractive pricing conditions that can be found in the capital markets via collateralized reinsurance or catastrophe bond issuance.
Guy Carpenter stressed that overall transactional costs for cat bond issuance are now more favourable than in 2012, when the TWIA Board rejected cat bonds due to the upfront costs and uncertainty over taking up the offered transaction. Guy Carpenter also suggested that service providers may now be happy to accept payment on contingency of the success of the cat bond, something which we’ve certainly heard that some smaller sponsors have been trying to push for. This would, according to Guy Carpenter, suggest that even legal fees for a cat bond transaction could be contingent or the deals completion.
Guy Carpenters representatives at the meeting suggested that pricing for capital markets backed reinsurance cover such as cat bonds could be 10% to 20% cheaper than the traditional reinsurance market at this time. Combine that with the multi-year approach of a cat bond and it’s clear that the current market could be very attractive to TWIA. TWIA itself said that it has noticed the increasing competition between cat bond and reinsurance capacity, with price competitiveness now particularly evident.
TWIA’s reinsurance coverage comes into play at around $2.3 billion of losses, after retention and pre-event bonding facilities, making it a relatively low risk attachment point for a cat bond. Were TWIA to move ahead with a cat bond they could certainly expect to find attractive pricing for that level of risk as it would also offer some level of diversification to investors, there not being any other ‘Texas only’ cat bonds.
However, TWIA is not convinced it is ready for a multi-year approach to its reinsurance protection and also believes that the effort required to get a cat bond to market could be more than the association can currently cope with in a short time scale. Another concern TWIA has is regarding the lack of a reinstatement option for collateralized or cat bond capacity, although pricing could overcome that particular concern.
Guy Carpenter said that the residual markets, of which TWIA is one, are particularly well suited to capacity from collateralized reinsurers and capital markets investor sources. They fit well with the overall risk-return profile that many of these collateralized sources of capacity are seeking. This could make terms for TWIA even more attractive in the upcoming renewals.
A spanner in the works of TWIA’s reinsurance renewals is the outcome of ongoing legislative discussions on reforming TWIA. These discussions aren’t due to complete until 27th May and TWIA’s reinsurance renewal is due on 1st June, making the 2013 decisions more difficult than the association has previously faced.
TWIA have even been considering letting its reinsurance lapse and moving its renewal to 1st July to separate it from the legislative session. Guy Carpenter told TWIA that there is a 1-in-1000 year (0.1% exceedence probability) chance of a hurricane breaching the $2.3 billion level in the month of June, so while being uncovered is risky it is perhaps not a risky as you may have thought.
This has certainly made life difficult for TWIA’s insurance and actuarial team when considering cat bonds for 2013. However the fact that catastrophe bonds keep coming up in its discussions, and that other similar state windstorm insurers already use cat bonds, suggests that TWIA will get there eventually.
Guy Carpenter suggested aiming for a 1st June renewal as usual, keeping all options open and one eye on the legislative session. The TWIA actuarial and underwriting committee would like to move towards a 1st January renewal if possible so that renewals are moved away from the wind season and any future legislative sessions. The renewal for this year will likely need to be at a $2.2 billion trigger level for the reinsurance programme but Guy Carpenter said that coverage will be cheaper so allowing more cover for the same outlay as 2012, even at the higher attachment point.
The TWIA actuarial and underwriting committee sent a recommendation to the Board that its reinsurance renewal contract at 1st June be on an annual basis with provision that it can be rewritten at 1st January if required. It’s now up to their brokers, Guy Carpenter to come back with proposals for this renewal.
The committee also passed a motion to recommend that the TWIA Board buy a mix of traditional and/or collateralized reinsurance depending on what is most appropriate and cost-effective. Catastrophe bonds were explicitly excluded from the recommendation for the 1st June renewal due to the perception of not having enough time to complete a cat bond deal at this stage of the year on TWIA’s side.
TWIA said that for a cat bond to be pursued it needs to have a six month lead time for the insurer to be able to undertake all necessary tasks, due to the subtle contractual differences to normal reinsurance. Guy Carpenter stressed that cat bond pricing in the last thirty days has dropped significantly and that cat bonds can be issued in a lower friction way if required. However the committee strongly believes that it does not have the time or resources to pursue a cat bond for the upcoming 1st June renewal.
It’s possible that the broker could come back with a cat bond proposal for the TWIA Board which might be found acceptable in the time-scale, but it does seem unlikely that TWIA would approve this based on the sentiment in this committee meeting. In January 2014 though, if TWIA successfully move the renewal date, catastrophe bonds may well be back on the agenda for TWIA once again and this time with plenty of time to pursue the strategy.
So it seems that TWIA will look to maximise the amount of reinsurance it buys and that the collateralized reinsurance market will likely participate in TWIA’s renewal as much as it wants to, dependent on rate-on-line and available capacity. The TWIA committee’s discussion certainly seemed to suggest that it is particularly keen to take advantage of perceived cost-efficiencies in collateralized cover at this time. It tasked Guy Carpenter with securing as much coverage as possible for the available budget from whatever source is most cost-effective.
The time is just not right for TWIA to enter the cat bond market right now it seems. Timing combined with legislative pressures will likely stop the insurer looking at a cat bond in 2013. We’ll update you when we next hear news of TWIA’s risk transfer and reinsurance plans and if the cat bond possibility changes we’ll let you know.
Other residual market or state-backed insurers are currently in the middle of cat bond issuances or considering issuing cat bonds: