Africa Can Tap Global Reinsurance Markets; Why Not Florida?

By Ray Lehmann | Right Street Blog | May 23, 2014

In what can only be taken as an exceedingly encouraging sign for emerging markets around the world, an African Union-created agency has established the continent’s first-ever catastrophe insurance pool, offering coverage to the nations of Kenya, Mauritania, Mozambique, Niger and Senegal to protect against extreme weather and threats to the food supply.

Capitalized with contributions from Germany and the United Kingdom, the agency’s newly created Bermuda-based specialist hybrid mutual Africa Risk Capacity Insurance Co. Ltd. is offering $135 million of coverage to the participating countries. The pool also has secured $55 million of index-based reinsurance, brokered by Willis Re and Willis’ Global Weather Risks Practice. Reinsurance claims will be calculated using satellite rainfall data and parametric triggers designed to account for each country’s specific mix of staple crops.

As the agency itself put it in announcing the deal:

The aim of the ARC catastrophe insurance pool is to reduce African governments’ reliance on external emergency aid. Currently international assistance is secured through an appeals system and then allocated on a largely ad hoc basis once a disaster strikes. Consequently, African governments affected by disasters can be forced to reallocate funds from essential development projects to crisis responses, exacerbating problems in other areas of their economies.

That’s sound planning, particularly as it comes at a time when a massive influx of third-party capital from hedge funds, pension funds and other institutional investors has forced reinsurance pricing to grow so soft, and terms and conditions so generous, that both credit and equity analysts are warning the sector is heading into “dangerous” territory. As reported by the ILS-focused blog Artemis.bm, the investment bank Keefe, Bruyette & Woods recently warned that:

On property catastrophe reinsurance specifically, KBW’s analysts note the growing concern that the influx of third-party reinsurance capital has significantly shifted property catastrophe reinsurance market dynamics, with softening now also emerging on other lines of reinsurance business.

In KBW’s view, attempts by some reinsurers to ward off pricing pressure by loosening reinsurance terms, conditions and coverages are a dangerous and under-appreciated side effect of the pricing pressure in the market.

Of course, until such point that the market softness actually pushes over into solvency-threatening territory – not currently a risk with such an over-capitalized industry – then what is a source of distress for bondholders and shareholders is a major boon for policyholders.

Which makes it all the more disheartening that one of the largest government-backed catastrophe insurance entities in the United States – the Florida Hurricane Catastrophe Fund – is not taking this opportunity to shift some of its $17 billion in potential 2014 obligations off the backs of taxpayers and onto a private market that is clamoring for more risk.

Coming into the year, we had hopes the time was ripe for risk transfer by the Cat Fund, with Chief Operating Officer Jack Nicholson presenting a plan buy up to $1.5 billion in private reinsurance for the 2014 hurricane season. Alas, the Florida Legislature closed out its 2014 session earlier this month with no action on that front.

Certain partisans will point out that, given a historically lucky streak of good weather, the Cat Fund is in the best shape it’s faced in years. According to the twice-yearly assessment released last week by Raymond James & Assoc., the fund’s financial adviser, it goes into the 2014 hurricane season (which starts next weekend) with an estimated bonding capacity of approximately $8.3 billion and total claims-paying capacity of $21.25 billion. That’s certainly a major improvement from the reports in the not-distant past projecting the fund would face a shortfall if a major storm were to hit the state.

But bear in mind that baked in to this apparently rosy outlook are a few major assumptions. One is that, if faced with a capacity-draining event or series of events in 2014, the fund would need to borrow up to $4 billion to meet all of its needs — bonds that would be financed by post-storm “hurricane taxes” on nearly every insurance policy in the state.

This would represent an extremely large bond issuance by municipal market standards. Since 2009, there have been only three municipal issues that were this large: two (one taxable and one tax-exempt) by the State of California that were each more than $6.5 billion, and a $4.1 billion tax-exempt issuance by the Puerto Rico Sales Tax Finance Corp.

The broker-dealers consulted by Raymond James expressed confidence that the Cat Fund would be able to raise the needed funds, although it is notable that Goldman Sachs, which traditionally had been the most bearish about the fund’s bonding capacity, has been dropped from the rotation of polled firms. Raymond James itself felt compelled to offer the caveat that, just because the Cat Fund would likely to be able to raise the money, doesn’t mean it necessarily will be on attractive terms:

As a less-frequent issuer with relatively less debt outstanding and primarily at the shorter end of the yield curve, the FHCF may not be as well-covered by investor credit analysts in the primary or secondary markets, even though it has strong credit ratings. This relative lack of exposure and investor familiarity could serve as a limiting factor in determining the FHCF’s potential market access in the short run.

What’s more, it is important to keep in mind that the report shows only that the fund would be able to cover its obligations for ONE bad hurricane season. If it faced back-to-back storm years that drain its capacity, such as Florida experienced in 2004 and 2005, the Raymond James report shows it would go into that subsequent season facing a potential $5.1 billion shortfall in its ability to meet all of its obligations.

All of which is to say that Florida lawmakers are once again foolishly rolling the dice on the weather, when far more stable, affordable and fiscally prudent forms of risk transfer are readily available (and, indeed, are being smartly exploited by the Cat Fund’s sister entity, Florida’s Citizens Property Insurance Corp.) This is one case where the First World clearly has a thing or two to learn from the Third World.

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