Twenty-five years ago, the devastating forces of Hurricane Andrew hit Florida. At the time, it was the costliest insured natural disaster worldwide, causing USD 27 billion in insured losses (in 2017 dollars). Florida, the state most exposed to hurricanes, has since become a laboratory for disaster mitigation and disaster-risk financing. What are the lasting consequences on the re/insurance market in Florida and worldwide?
Increasing role of government in insuring coastal risks
Before 1992, insurance coverage for Florida's most vulnerable properties was limited, and the state backed the Florida Windstorm Underwriting Association to insure beachfront property; but with limited scope. After Andrew, the lack of availability reached critical levels, as private insurers withdrew capacity. In response, the state expanded its role as the insurer of last resort. In 2002, two state high-risk insurance pools were merged into Citizens Property Insurance Corp. Florida also created a mandatory public catastrophe reinsurance fund, the Florida Hurricane Catastrophe Fund (FHCF), from which all insurers selling homeowners insurance in the state are required to purchase some coverage.
With more hurricane activity and other market disruptions, the Citizens policy count rose rapidly and reached a peak of around 1.5 million in 2002. Citizens had evolved from a market of last resort to the state’s largest property insurer. The magnitude of this exposure was widely considered unsustainable.
One important difference between private insurers and government-run entities is that private companies are pre-funded and need to hold sufficient capital to pay catastrophic claims, while government-run companies can run deficits and charge all policyholders in the state after a catastrophe through assessments which are added to everyone's premium payments. These assessments have raised issues of fairness and market distortion since not every policyholder has the same exposure to coastal storm risk.
Efforts to depopulate Citizens have succeeded in reducing the government's exposure by creating a class of specialized Florida-homeowners-only insurers that rely strongly on international reinsurance capacity. Citizens and the FHCF now also buy reinsurance and alternative capacity to extend capacity and spread the risk globally. By 2016, the Citizens policy count fell below 500,000.Nevertheless, the state still plays a major role in the Florida insurance market, which has become permanently politicized.
Permanent changes to the global reinsurance market
The concept of securitizing catastrophe risks (e.g., cat bonds) was developed in Andrew's aftermath. It was spurred by the motivation to bring more risk-bearing capacity to the catastrophe reinsurance market. Additional capacity was important because the global reinsurance market was suffering from a capacity shortage caused by multiple factors. Those included the early 1990s fallout of the Lloyd's crisis, and skyrocketing claims from US asbestos and environmental liability.
A number of offshore startup companies were thus formed in Bermuda. That added new capacity that was unencumbered from legacy US liability claims. The location of Bermuda made sense since there was already a niche captive industry on the island which had been kicked off by the US-liability crisis in the late 1980s. Post-Andrew, offshore capital became a significant source for reinsurance capacity, especially for US-cat risks. The offshore re/insurer business model was then boosted by two more waves of startups, following 9/11 and Hurricane Katrina.
Cat bonds remained a niche product through their first decade but the concept matured. The first significant boost came after Katrina. The market segment of alternative capacity, which includes cat bonds and newer offshore reinsurance business models such as collateralized reinsurance and sidecars, soared in the low-interest environment after the financial crisis. Today, the property cat reinsurance market is bifurcated. It consists of a commodity segment (with a large share of alternative capacity and small offshore re/insurers) and a tailor-made solutions segment. That second segment is led by a handful of large global reinsurers.
The proliferation of cat modeling
Among the big lessons learned from Andrew was an awakening to the magnitude of Florida’s cat exposure. The impact of the hurricane far exceeded expectations of the maximum potential losses for the re/insurance industry. Before 1992, the industry didn’t adequately understand its exposure to different types of catastrophic losses. Companies couldn't properly quantify how much reinsurance they should purchase, how much exposure they were retaining, and how much they should charge for providing coverage in high-risk areas.
The first cat models for hurricane exposure were created in the late 1980s, but were not widely used. Moreover, data about historic storm tracks, value and location of exposures, and the vulnerabilities of buildings to specific storm scenarios was limited. The insurance industry's attitude toward models changed instantaneously in 1992 and jumpstarted the cat modeling industry. The continuous collection of data and the exponential growth of computing power further allowed quantum leaps in the sophistication of meteorological and cat modeling.
The 1994 Northridge quake triggered the addition of earthquake as a modeled peril. Rating agencies' use of cat models as an input for insurer financial strength models further promoted cat models' proliferation. Today, even solvency regulation is incorporating the use of cat models. This is the case for example in Europe under Solvency II, the Canadian statutory Federal capital requirements and as part of ORSA (Own Risk and Solvency Assessments), which are compulsory in many jurisdictions. In more recent years, modeled perils have been expanded to include coastal flood (boosted by hurricane Katrina's large un-modeled flood losses), tornadoes and riverine flood. The emergence of a thriving independent cat modeling industry was in turn instrumental in facilitating the development of the business models of providers of alternative capital, for whom the use of models and index-based triggers often substitutes the need for underwriting.
The big picture, 25 years later
The global reinsurance market changed permanently in the wake of Andrew. Market fragmentation increased, and some segments became commoditized. At the same time, the importance of brokered and transactional business rose. Moreover, market participants embraced scientific modeling. And the market on the whole became more fluid due to the inflow of fresh investors' capital and convergence with capital markets. Overall, these changes made global reinsurance more resilient.
Climate/natural disasters: Disaster risk, Resilience
Category: Climate/natural disasters: Disaster risk, Floods/storms, Resilience
Location: Florida, United States