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Involuntary assessment angst

Frequent and severe hurricanes in 2004 and 2005 saw insurers walk away from writing voluntary business in coastal areas. As the pressures on the state residual market mechanism – known as the Coastal Pool – increase, so coastal insurers are more likely to face an involuntary assessment. As the cost of these increases, insurers have given the thumbs up to new cover.

Challenges increasing

Insurers writing business in coastal areas face a number of challenges, specifically:

Recalibration of catastrophe models, with significantly higher and more frequent expected losses
Rating agency and regulatory pressure to purchase property catastrophe reinsurance coverage reflecting the updated model and risk-based capital benchmarks
A growing requirement for more property catastrophe protection

This situation has caused many companies to try and reduce their exposure to catastrophic risk, and the associated reinsurance costs, in coastal areas, leaving the state residual market mechanisms, or so-called Coastal Pools to pick up the tab. However, as insurance companies move away from writing voluntary business in coastal areas where the potential for damage is greatest, so they become more likely to be subject to an involuntary assessment instead.

Assessments hard to estimate

A major disadvantage to companies in this process results from the difficulty in estimating potential costs of involuntary assessments due to the rate of growth of the residual pools and plans. The most significant pool, in terms of size and potential for loss, is the Texas Windstorm Insurance Association (TWIA).

The size of the Texas Wind Pool is currently estimated to reach around $65bn by the end of 2007. This figure is likely to be substantially higher than most companies anticipated when they were purchasing their current catastrophe reinsurance programs.

The result of higher exposure volumes in these risk pools is companies needing to purchase more cover. This is both to accommodate the probable maximum loss (PML) now envisaged by the catastrophe models, as well as to provide adequate protection for increases in potential loss assessments from the Wind Pool.

A major disadvantage to companies is the difficulty in estimating potential costs of involuntary assessments due to the rate of growth of the residual pools and plans

Although companies may currently offset their assessment, through reduced premium taxes over a five year period, the disadvantage of this is the period of time over which the money can be recouped. Negative cash flow implications can result which could be further exacerbated if more hurricanes make landfall during this five year period. An insurance-related bill considered in the recent Texas legislative session would have done away with the premium tax credit and replaced it with pre- and post-event funding, but the bill was not passed.

TWIA product interest

One solution would be to provide an assessment catastrophe product which responds specifically to TWIA assessments.

BMS has met with major catastrophe reinsurers in Bermuda and London to explore the appetite for such a product and to discuss potential capacity and pricing. There has been significant interest from both marketplaces. Reinsurers also accepted that, for such a specifically targeted coverage, the cost should be attractive when compared, for example, to what companies currently spend on their top layers.

Exposures to the Wind Pool are increasing at a dramatic rate and predictions are that this trend will continue. Over the six month period to 31 May 2007, exposures increased by over 20% to $46.5bn. Current predictions are that this figure will increase a further 35% by the end of 2007.

While it may be difficult to accurately calculate the exact losses, the extreme increase in exposure values coupled with the more severe return periods predicted by the latest models is likely to have a considerable impact on future wind pool assessments.

Not if, but when

For example, Galveston County alone represents 70% of total Wind Pool exposure.

Assuming a 15% PML on aggregate values for a direct hit on Galveston only, a ground up loss to the pool would exceed $6.8bn. The resulting assessment attributed to a loss of this magnitude would have a very serious impact on companies which may not yet have purchased sufficient cover.

Considering the effect climate change is having on the environment, it is no longer a question of if a loss of this magnitude will occur, but rather a question of when.

Companies will need to ensure that when it does happen, they have effective recovery options in place.

Tony Provenzale