Excess capacity in this year’s Florida market

The Florida peninsula is the most important market for property reinsurance in the world. Each summer, the third most populous state in the union braces itself for another Atlantic hurricane season. In Florida’s esoteric insurance market, insurers buy reinsurance protection at the beginning of June each year.

Lara Mowery is a Managing Director at the reinsurance broker Guy Carpenter. She discusses the drivers of the continuing rate reductions in Florida and what it means for the rest of the market.

What role did ILS funds play in this year’s Florida reinsurance market compared with ‘traditional’ reinsurers?

The influx of capital into catastrophe bond and collateralised reinsurance funds has allowed for decreasing pricing which, in turn, has led to increased demand for reinsurance.  Two years ago, we saw an uptick in the overall amount of reinsurance purchased in Florida. Last year demand was flat but this year we did see a slight uptick again in the amount of protection that was purchased.

There is a wide variety of approaches between individual insurers in terms of how they tend to use that capacity from ILS funds. Some have looked at it and taken advantage of it directly, embracing those sources of capacity in their programmes. Much of this has come about as a result of growing needs for cover or shifts in products utilised.  Others that haven’t changed their programme structures materially can find it more difficult to find room on placements for new players, where the existing panel is also quite competitive and has a historical trading relationship with the cedent.

But companies do generally understand that even if they aren’t using collateralised capacity directly, or if they’re using it in supplemental programmes, they’re definitely benefiting from that capacity being in the marketplace. If you look at retrocessional coverage, for instance, much of this limit is supported by collateralised capital and it’s helping traditional reinsurers in the way they are able to write business and approach the market. So the fact that collateralised capacity is in the market has a broad impact, whether a company is directly utilising it or not.

Was excess capacity still the main driver of the direction of reinsurance pricing at this year’s June 1 renewals?

Clearly we’ve had some very significant pricing movements in the Florida environment in recent years. As more capital has come into the market and cat bonds have played a bigger role, the Florida renewals in particular have been impacted by this capacity diversification as the key exposed cat region in the world.

The market generally benefits when a reinsurer can use capacity in geographically diverse ways.  Florida’s peak zone status makes this more difficult.  However, some of the newer sources of capital actually experience reinsurance as a diversification in and of itself. So they weren’t quite as focused on trying to diversify their reinsurance portfolio geographically and therefore weren’t as sensitive necessarily to the amount of capital exposed in Florida.  More capital with an interest in Florida risk led to decreased returns.

Last year we did see a noticeable moderation in the rate of price decline however. Whereas previously we had seen double digit and high-single-digit decreases, last year was a more moderate price decrease along with less excess capacity through those June 2016 renewals. Last year excess capacity was 22% in total, which meant that 22% of authorisations weren’t needed to fulfil reinsurance programmes.  This number represented excess capacity for all June 1 catastrophe programmes in the U.S.; Florida programmes saw capacity tighten even further.  This year excess capacity increased to 37%.   While average price declines did not jump back up in the double digit range, overall decreases averaged slightly more in 2017 versus 2016.

Pricing is something that reinsurers are very sensitive to and watching closely. We’re at a point where reinsurers are evaluating all of the characteristics of each individual renewal and making renewal-by-renewal decisions on what they can support. As with last year, there were programmes reinsurers had long supported that they had to cut back or decline in some cases. They looked at individual company characteristics, made underwriting judgements and didn’t just write anything that came in front of them.

How about Citizens, the state-owned insurer of last resort? Has Citizens’ efforts to reduce its exposure had an impact?

The transition of policies out of Citizens and into the private market has clearly had an impact on the companies who have taken on a lot of that risk. One outcome is that they have had to buy more reinsurance to protect themselves.Citizens’ approach is to use both traditional reinsurance and ILS to transfer risk.  Each year, the company reviews market conditions in both markets relative to their needs before formalizing a risk transfer strategy.  Last year, Citizens utilised more ILS capacity as a result of previous multi-year catastrophe bond issuances and a subsequent reduced traditional reinsurance demand.  This year that strategy reversed as previous catastrophe bonds matured and limit was replaced with traditional reinsurance.

However, in terms of the impact on the wider market, the overall reinsurance demand has increased significantly as a result of policies being depopulated from Citizens.  On one hand, Citizens needs less risk transfer as they get smaller. The private market, on the other hand, has to adjust their risk management strategy which typically results in purchasing additional reinsurance as they depopulate policies from Citizens.  Further impacting the increase in reinsurance demand is the fact that the majority of policies that were depopulated from Citizens were from the Personal Lines Account, where Citizens has not historically purchased reinsurance.

Did Hurricane Matthew have much of an impact on renewal discussions?

Matthew was more of an individual renewal factor for this year, and a fairly minimal one. At one point prior to landfall it was predicted to be a $30 billion-plus industry event and that could have had more of an impact on companies’ renewals and their assessments of their going-forward needs. But, in the end, Matthew fell more into the discussion of the event it could have been.

Matthew was impactful from the standpoint that for many companies it was the first hurricane to really put their catastrophe management programmes to the test since 2005. It also gave reinsurers a front row seat, and the opportunity to ask insurers questions about how their response plans had worked, to consider how companies shared information and how the claims were handled and what process they went through.

Another important consequence of Matthew was conversations around the definition of a loss occurrence. At one point Matthew was forecasted to loop back around and make a second landfall. That prompted a lot of conversation with clients around exactly how their reinsurance coverage would respond, particularly as the majority of Florida programmes contained a 120-hour loss occurrence definition. Guy Carpenter had many conversations with reinsurers and going into 2017 renewals crafted an approach to include a named-storm definition for hurricanes where appropriate, so that when an event happens, the product works in the way all parties expect and companies are able to fully utilise the limit they are paying for to cover loss from a single event.

What is the effect of the assignment of benefits (AOB) crisis?

AOB is certainly a topic for discussion and it’s something that companies were prepared to talk about through their renewals. Reinsurers were very curious about what the impact to a given company has been and whether different companies were doing different things to handle it and therefore experiencing different outcomes regarding AOB.

Every year reinsurers like to delve into companies’ qualitative factors. It’s not just about putting the exposure into a model and the model spitting out a number and solely going off that number. This year, in part because pricing has tightened to the extent it has and partly because of things like AOB and the test of companies’ catastrophe management plans during Matthew, we saw a bit more focus on those qualitative factors.

Reinsurers in general have become more sophisticated about evaluating individual company characteristics and we are seeing more variability in renewals. It makes it more difficult to generalise the market and its behaviour. While there is general pricing movement in one direction or another, Florida renewals tend to be more customised than they used to be.

The views expressed herein are solely those of the author and do not reflect the views of Guy Carpenter & Company, LLC, its officers, managers, or employees.

Posted: Monday, June 19th, 2017