In a review of the Florida market, Bermuda Re spoke with domestic insurers and Bermuda reinsurers about the symbiotic and deepening relationship that exists between the two markets.
A Bermuda reinsurer's view
With Florida moving to reduce state involvement in the provision of re/insurance coverage, there are growing opportunities for local insurers and Bermuda reinsurers alike to further develop their presence in the state. Citizens, the state-backed insurer, has already moved to shed some of its exposures and is—after recent debate in the legislature—now viewed by the state as an ‘insurer of last resort’. Suggestions that $3 billion in funding would be withdrawn from the Florida Hurricane Catastrophe Fund (FHCF) proved premature however, with the Florida Senate Banking and Insurance Committee opting to retain the limit, citing a resulting 3.5 percent increase in rates as the likely result. The issue will however be re-examined by the committee in future and it appears that with Florida’s efforts to reduce the ‘public purse’s’ exposure to hurricane losses, there are growing opportunities—both for Florida domestic insurers to write more business, and for Bermuda reinsurers to expand their Florida portfolios.
David Bigley, head of US property catastrophe reinsurance at Endurance, estimates the level of additional capacity that is likely to enter the market at $1 billion, or an additional 10 or so percent of the $11 billion of reinsurance capacity purchased by the Florida market last year. A portion of this increased demand in capacity will result from the drawing back of state involvement through the depopulation of Citizens. As Bigley outlined, “there is certainly ample appetite in the private marketplace for that additional limit, in particular with Bermuda reinsurers.” He added that a drawing back of state involvement last year had prompted an increase in interest, and that a similar upswing in capacity expected in 2013 will serve to deepen ties between Florida, its insurers and the Bermuda market.
“The relationship between Bermuda and Florida is symbiotic,” said Bigley, with Bermuda accounting for around 60 percent of reinsurance capacity bought by Florida domestic insurers. The level of coverage and the strength of relationships established between the two markets have deepened over time, he said, with many Bermuda players building up their Florida portfolios as their global portfolios have grown.“Florida is an important part of any property cat portfolio, and certainly one that Endurance plans to continue to grow.”
Susan Patschak, CEO of Canopius, Bermuda spoke in a similar vein, indicating that the state accounts for an enormous amount of premium volume in Bermuda, with the two markets intrinsically linked. Helping matters is the high regard in which Bermuda markets are held in Florida. Florida players “view Bermuda expertise as being pretty sophisticated— able to deliver value-added insights to the risk selection process, while having a close understanding of the market”. These capabilities have helped place Bermuda at the forefront of Florida minds.
Patschak did warn, however, that the level of demand for Bermuda reinsurance capacity is such that one of the key questions Bermuda reinsurers need to address is not whether to involve themselves in the Florida market, but how to select the optimum insurance partners. Reinsurers should seek out those “clients that are on their data and are seeing the trends before anyone else”, Patschak warned. And it is by developing meaningful relationships with such partners that reinsurers can add real value to their Florida portfolios. There is inevitably a “pecking order” associated with the most attractive programmes, said Patschak, but by building long-standing and collaborative relationships it should be possible to partner with Florida’s brightest prospects.
The act of differentiation
With so many Bermuda players involved in Florida, and interest likely to increase in response to the drawing back of state coverage, the question is how can reinsurers look to differentiate their offering? As Patschak outlined, there is no shortage of demand for reinsurance coverage, but it is in attracting and retaining the best performing insurance partners that Bermuda reinsurers can really excel within the market. Addressing how reinsurers can differentiate their offering in the market, Patschak said that local insurers are looking for a partner “with their own opinion. They want a reinsurer that really understands the Florida market and is not there simply looking for a capacity play”.
Bermuda players must bring real added value, she said, with a close appreciation of the market and its business being an important part of the value proposition. “I encourage my Florida clients to pick up the phone and call me whenever they have an issue or need advice. Ours isan advisory relationship and I feel it is always good to bounce ideas off one another. These are very much business and social relationships in which you share knowledge.” Close attention and an understanding of the market’s nuances is evidently key. As Patschak made clear: “Your resources need to be concentrated when writing Florida business, and with understanding comes better service and price.”
Meredith Head, senior vice president, property catastrophe at Tokio Millennium Re, echoed Patschak’s thoughts on reinsurers’ desire to select the best Florida insurance partners, and suggested that “some reinsurers wanting to gain a strong position with a particularly desirable Florida insurance partner might seek to use price competition to gain an advantage”. While price is an important element in any deal, the impact of reinsurance cost is heightened for Florida insurers, as it comprises such a significant component of their total annual expenses.
Consistency of price is another key differentiator, said Patschak. Citing her team’s response to hurricanes Katrina, Rita and Wilma back in 2005, she said that their own individual view of risk—one which was decided upon early, rather than waiting to follow the market— was one that was ultimately remembered by primary clients. “Clients tend to remember when you don’t try to scalp them.” And presumably, they also remember when you do.
"Cat models play a significant role in understanding wind risk, but it is clear that insurers are looking to their partners for additional insight into their exposures."
Also playing into the pricing dynamic, said Head, is the extensive use of catastrophe models, which have “contributed to the establishment of minimum price hurdles on most programmes. However, reinsurers today are increasingly applying adjustments to the model results to better reflect factors such as an insurer’s underlying policy conditions, underwriting and claims handling practices, or other features which can affect loss potential, but which are not always fully captured in the models. Making adjustments to the modelled results expands the range around the market view of risk, which can encourage some differences in reinsurance pricing”.
Head added that limited hurricane activity in Florida in recent years, strong reinsurer capital bases needing to be put to work, and rising interest from alternative capital sources might also influence the price dynamics during the 2013 mid-year renewals, though the extent of this remains to be seen.
Rising levels of alternative forms of reinsurance certainly raise the prospect of a changed landscape in Florida. Bermuda is at the forefrontof these alternative forms, but such forms do have the potential to both complement and erode the strengths of bricks and mortar players on the Island. Bigley said that Endurance’s view was that “alternative forms of reinsurance are strengthening the overall Bermuda-Florida relationship”, with their various forms, capacities and trigger types helping to provide clients with a breadth of solutions. Bigley did, however, indicate that their scope would remain limited as there are constraints on where alternative forms can play in a programme meaning “that there will always be a role for traditional ultimate net loss reinsurance”.
$37 billion: running estimate of catastrophe claims paid to the US by Bermuda re/insurers between 2001 and 2012 (Source: Association of Bermuda Insurers and Reinsurers)
Addressing how Endurance differentiates its offering, Bigley said that it is through bespoke customer solutions. Following the expiration of the FHCF’s limited apportionment company (LAC) layer for example, Endurance had responded by working with several long-standing clients to provide tailored solutions to make up the shortfall in coverage, offering them programmes that optimised their reinsurance purchase. This ability to “provide clients with customised options is a key differentiator in the market”. He agreed that price remains a telling differentiator, but added that Endurance’s approach to the market had never been an opportunistic one, or one driven by price, rather “our approach is to work collaboratively and build long-term partnerships”.
Head agreed that price is not the sole driver of differentiation, with “superior security ratings and historical relationships” also playing an important role for those insurers looking to partner with strong, dependable reinsurers over the long term.
She continued that another area of potential differentiation is through the size of capacity offered. Some reinsurers are able to offer large amounts of capacity, which can enhance their position on a catastrophe placement, though she added that supply and demand dynamics in the current environment could potentially dampen the impact of that approach this year.
Finally, concluded Head, reinsurers can differentiate themselves by offering multi-year commitments to their insurance partners. In prior years, there has been some reluctance among reinsurers to do so, given the volatility of the Florida market, but with multi-year capacity featuring in the alternative market space, “traditional reinsurers are beginning to consider extended commitments.” If reinsurers offer multiyear protection, it will likely be directed towards those companies with the most stable, or at least the most predictable portfolio characteristics, and those with the greatest longevity potential.
In a market prone to sizeable wind risk, cat models play a significant role in understanding risk, but it is clear that insurers are looking to their partners for additional insights into their exposures. Patschak said that Florida cedants are looking for reinsurers with an educated view of risk, one that is a blend of the major models and that drills down into modelled assumptions. She said that it is important to sit down with clients to discuss what they are seeing in their modelled assumptions. With numerous “working parts”, there are a “lot of pieces to the puzzle” she said, and as such reinsurers really need to understand the business, not simply rely on modelled assumptions.
Nevertheless, model changes such as RMS 11 have served to verify some of the industry’s assumptions, said Bigley, and they did not directly affect reinsurers’ Florida strategy. He said that more sophisticated reinsurers have “evolved to the point where we have developed our own view of risk that is based in part upon the commercial models, but not directly tied to every change within those models”.
Head agreed that relying exclusively on raw modelled results can be dangerous. “Florida insurers often have very detailed exposure data to feed into the models, and the state has also endured a relatively high number of historical storms which have been used in model calibration, so the results there should be amongst the most reliable in the world. Despite these positive features, however, considerable uncertainty still remains.”
She cites recent model version changes which “produced substantial shifts in expected loss for many companies, raising questions about the validity and the stability of the results”. Tokio Millennium Re addresses some of these concerns through blending modelled losses based on in-house analyses of the strengths and weaknesses of the various models, and by adjusting the modelled outputs to incorporate important risk features that are not fully captured in the models.
Evidently models play an important role in understanding risk, but there is an increasing realisation that developing an educated and independent view of risk will help reinsurers burnish their credentials in discussions with Florida insurers.
The drawing back of state involvement in the provision of re/insurance coverage presents significant opportunities for Bermuda players, and it is clear that the industry welcomes reduced state involvement. Bigley said that while financially sound, Florida should be transferring “a larger portion of its hurricane risk to companies and jurisdictions outside of the state, such as Bermuda, where there is the expertise, experience, capital and global reach to better manage it”. He said that recent efforts to de-risk the portfolio at Citizens “should be applauded” and that combined with organic growth among domestic insurers there are definite opportunities for reinsurers to develop their portfolios. “It certainly appears as though the regulatory environment is improving in Florida and the economics of the underlying insurance business are too, to the point where investors are looking to put capital into the state.”
Patschak was equally bullish about the ability of the private market to take on state risk. “If the private market can take and handle the risk, then it should,” she said. She agreed that there is the need for an insurer of last resort in the form of Citizens, but added that at present it is going rather beyond that remit. Turning to the FHCF, Patschak said that it is the strongest it has been since its inception in terms of its balance sheet and its ability to source funding post-event, but said that it plays a valuable role in the market. “Citizens’ position in the market needs work, but the Florida Office of the Insurance Regulator does a thorough and significant job in the state.”
Head added that the state’s recent work in addressing issues around fraud, public adjusters, and sinkholes had helped to increase the profitability of domestic insurers, which has in turn has created more opportunities for Bermuda’s catastrophe relationships.
Efforts to shift some of the state’s hurricane risk away from the ‘public purse’ through initiatives like Citizens depopulations, reinsurance of Citizens’ coastal exposures through both traditional reinsurance and cat bond placements, and the reduction of the FHCF’s coverages have all expanded the opportunities for Bermuda reinsurers writing business in Florida.
Florida continues to represent a sizable portion of Bermuda reinsurers’ business platforms, even as companies have developed an increasingly global and diverse footprint. Increasing insured values for many Florida insurers and the drawing back of coverage provided by the state will certainly help to pique further interest in Florida, and with all the opportunities available in the market, Bermuda will be watching the developments with interest.
A Florida insurer’s view
Looking for a partner
Florida-based insurers are an attractive prospect for Bermuda’s and international reinsurers looking to write cat risk, but when looking to build relationships it is worth exploring exactly what Florida-based insurers are looking for in their reinsurance partners. It is clear a number of issues factor into the decision.
As Roger Desjadon, CEO of Florida Peninsula outlined, as a sophisticated buyer of reinsurance, Florida Peninsula is looking for “creativity in approach to our programme from reinsurers”. He said that vanilla reinsurance offers little in the way of added value, with his company looking for originality in analysis and programme structure.
Reese Bowen, president at St John’s Insurance spoke in a similar vein, arguing that “an ability to provide intellectual capital on our entire ceded portfolio” is an important differentiator for the company, with Island expertise a much sought-after commodity. Bowen added that capabilities in enterprise risk management (ERM) are also regarded as being an attractive addition, with the best reinsurance partners able to provide “validation of our ERM, as well as statistical analytics services”.
Rating and capital also play their part in the decision, with Bown emphasising the attractions of reinsurers with strong captial position in a market so exposed to sizable cat risk. Desajadon concurred, arguing that "ratings are critical when choosing a reinsurance partner". Miguel Barrales, president at Universal, added that a bench of strong reinsurers helps bolster the financial strength rating of primary players, with its impressive bench of strongly-rated reinsurers, is an obvious market within which to source such capabilities.
Barrales added that "equall important are stability and predictability in terms of the reinsurer's view on Florida exposures and price". Building relationships over the long term, it is essential that reinsurers do not suddenly and dramatically change their view of exposures, or their appetite to write such business, he said. Sudden changes can be "very disruptive to programmes", with Universal emphasising the need for stabiliyt in its reinsurance relationships.
Desjadon also spoke of the need for consistency, warning that "there is a tremendous tendency in the markets nowadays to not take a partnering approach, but rather a more unilateral approach”. Too often there is a short-term view on pricing, he said, with some markets worrying only about the coming year. “That’s not really the kind of relationship that we work hard to establish with our reinsurers.” It was clear talking with all three markets that Florida insurers value true partnership in their reinsurance relationships, but as Desjadon cautioned, it is a term that is too often “thrown loosely around these days. Real partnership is something that should endure through both good times and bad”.
Barrales concluded that reinsurers whose approach to pricing differentiates the capabilities of primary players are viewed in a favourable light by Universal. As he explained, issues such as solvency, ERM, control of exposures and liquidity standing should all be factored into pricing decisions, with reinsurers rewarding best in class, rather than taking a uniform view of the market. Again, close cooperation and a good overview of the market—areas in which Bermuda markets tend to excel in Florida—remain key to building positive and lasting relationships with Florida players.
Third party capital in the form of cat funds, insurance-linked securities (ILS) and sidecars have gained considerable traction in recent months, with peak peril risks a significant component of the landscape. Florida and its risks are an obvious fit for the alternative space, with a number of Florida markets sourcing alternative capacity from Bermuda and beyond. Desjadon was enthusiastic about the value of alternative forms, arguing that they provide an additional, welcome source of capacity for Florida insurers.
Bowen added that such forms represent a “complementary part of any ceded programme and those that have such products can expect to enhance their position in any cedant’s portfolio”. Addressing St John’s position, he said that alternative forms represent less than 10 percent of their reinsurance coverage and as such “aren’t a deal-breaker”, but indicated that the growing capacity offered by alternative reinsurance was a welcome addition to the market.
"State involvement in the provision of reinsurance to domestic insurers has helped the marketplace, but it simply is not sustainable over the next tow to 10 years."
Barrales, for his part, said that Universal is not involved in the ILS space, although collateralised reinsurance accounts for around 6 percent of its reinsurance allocation. He said that traditional reinsurance has generally been viewed as being more economically attractive by Universal, but that he sees the collateralised and ILS markets gaining momentum. Such capacity is a welcome addition, he said, and as the market has developed and established an appropriate price for exposures, it is increasingly displaying the potential to smooth pricing fluctuations following a loss event.
“Such forms are becoming a new option for US insurance companies and looking at some of the capacity entering the market earlier this year, there are indications that there is a convergence of pricing relative to the traditional market,” said Barrales. Reinsurers who are able to offer alternative forms of capacity can hope to benefit from this increased interest.
$87 billion: gross probable maximum loss for Florida following a one in 250 year event. Source: Florida Office of Insurance Regulation
Addressing whether alternative vehicles are viewed in a similar or less favourable light than traditional reinsurance, Barrales said if it is extended by well-established reinsurers with whom the company already has links then it is generally viewed in a favourable light. Pure collateralised markets, for their part, “help to extend useful capacity when trying to complete the placement of a layer or a particular programme”, said Barrales, but questions remain regarding how exactly they will react following a major loss event. It would seem that reinsurers who can extend both traditional and innovative forms of capacity, within the framework of a trusted market reputation, are best placed to take advantage of insurers’ interest in exploring their reinsurance alternatives.
Bermuda has consistently played a leading role in the Florida market, with links between the two markets running deep. Bermuda’s proximity to the market—both geographically and professionally—has helped to deepen ties, and close cooperation is evidently a prominent feature of the relationship. But where do US insurers think their Bermuda counterparts could improve?
For Desjadon, one of the market’s greatest strengths could also be one of its most telling weaknesses. As he explained: “What Bermuda reinsurers are particularly good at is modelling portfolios, modelling risk and analysing those models from a purely quantitative standpoint.” However, such an approach has meant that Bermuda markets are “sometimes less adroit at writing and differentiating companies than say London”.
“Some Bermuda markets say that they spend a lot of time differentiating Florida insurers and then in the same breath tell you that they are on 30 programmes in the state. It is hard to substantiatethe notion that you’re selective when you’re on two thirds of the market,” said Desjadon. Bermuda markets are however getting better at differentiating their relationships, he said, with the growing maturity of the market helping to instil a more long-term view of risk and partnerships. And a longer-term view of the market is all the more pressing in a highly regulated market such as Florida, he said.
“Insurers in Florida face significant challenges from legislators and regulators because the public are so concerned about both the availability and affordability of coverage. Reinsurance plays an enormous part in that equation and violent swings in pricing on a six to 12-month basis really exacerbate the issue. Part of the challenge for reinsurers—and the opportunity—is to learn how to abate some of those concerns and to make the market work for everyone. To do so they really have to take a longer-term view of the market.”
All three insurers did however state that Bermuda reinsurers have not been slavish in their approach to modelled assumptions, and have instead sought to establish their own view of exposures. Those who do so robustly will evidently be viewed in the most favourable light by their Florida partners.
A delicate ecosystem
Models have always been a component of the Florida market, but their veracity has come under increasingly close scrutiny in recent years—particularly following the release of RMS 11, which caused many markets to re-examine their modelled assumptions in the US. Talking with all three insurers, it is clear that any over-reliance on models and the individual results derived from particular modelling firms are viewed in a decidedly sceptical light when looking for reinsurance partners. As Desjadon made clear, when talking about models it is important to understand “that they’re all wrong. How could any predictive model accurately determine the scope of an event no-one controls?”.
Addressing RMS 11 and its troubled roll-out, Bowen was equally critical, arguing that his company’s view of the company’s models was “never favourable”, labelling the modelling firm’s recent assumptions regarding storm surge as “nonsense”. Desjadon said that the development and roll-out of imperfect models are “a perfect example of how catastrophic damage can be wrought on an ecosystem if firms are not careful how they introduce change”.
“If all of a sudden there is a change in the ecosystem—whether it is driven by changing capital market demand, model change, opportunistic pricing, or a shrinking cat bond market—the market faces two choices: either it buys less re/insurance or it puts itself in a precarious financial position paying for that coverage,” said Desjadon. If people buy less coverage, it jeopardises the whole marketplace, “because if there is a storm [whether real or metaphysical] everyone suffers”.
If they do buy, and place themselves under financial strain, this could lead to a potential systemic crisis, one that could prompt regulatory action, he explained. Dramatic change threatens irreparable damage to the ecosystem, said Desjadon, which is why consistency in understanding of exposures is such an important component of the insurer-reinsurer relationship.
Further complicating matters is the regulated nature of the Florida market. When dramatic price changes affect the market—as a result of model changes, for example—insurers aren’t always able to pass rate increases on to the consumer, said Barrales. Instead they may be forced to accept and absorb reinsurance rate rises—subsidising policyholders for a year or two—until such time as the regulator allows them to pass rate increases on to the public, he explained. Such a situation makes dramatic changes to the ecosystem particularly unwelcome as insurers are forced to shoulder the burden of equilibrium. As such, Florida insurers have tended to view those Bermuda players that are more sceptical of dramatic changes in modelled assumptions in a more favourable light, with the best reinsurers helping to smooth dramatic changes in rates.
Despite the brouhaha associated with the release of RMS 11, Desjadon said that reinsurers have—by and large—proved themselves sophisticated in their approach to dealing with such radical model changes. “They didn’t allow themselves to take the bait hook, line and sinker,” he said. Instead many Bermuda markets “only nibbled around the edges of RMS 11”, while the smartest reinsurers didn’t even try to assimilate RMS’s changes. RMS for its part was also forced to reassess its position, with the modelling firm doing so in a mature— if reflexive—manner, he said. Despite their evident importance to the market and its understanding of risk, insurers evidently value those partners who take a more independent view of model change. Gradual, informed change to the ecosystem is the key to its stability.
A stately exit?
One of the other key dynamics affecting the Florida market is the ‘statutorily mandated’ participation of the state in the Florida Hurricane Catastrophe Fund (FHCF) and through Citizens, the statebacked insurer. While they are very different animals, both have a significant impact on market dynamics and it is clear from talking with all three panellists that state involvement is viewed in a decidedly mixed light by the Florida insurance community.
For Barrales and Bowen, state involvement in the market has been a necessary evil, but both argued that its ongoing presence should (and is being) reduced. Bowen admitted that state involvement had served as a “counterbalance to the marketplace”, but added that demand and availability should ultimately dictate the marketplace. Bowen agreed that state involvement in the provision of reinsurance to domestic insurers “has helped the marketplace, but it simply is not sustainable over the next two to 10 years. I suspect the government will see what happens next time the wind blows and continue to accelerate its exit from the market”.
Barrales also spoke of the need for a drawing back of Florida state involvement. “The cat fund had good intentions, but has had unintended consequences,” he said, with one of the major issues being the FHCF’s ability to pay. Barrales said that insurers don’t enjoy the same level of certainty regarding the fund’s ability to pay following a major event that they do in the commercial market. This leaves some insurers concerned about having to explain to policyholders why they can’t immediately pay for losses as they look to recoup them from the FHCF. As a result insurers have to purchase protection against possible shortfalls and “that shouldn’t be how the market should work”. Barrales did however add that those at the fund and in the market are on the same page regarding the need to downsize its position. The recent decision to retain $3 billion worth of funding for the cat fund by the legislature appears only to be a short-term measure.
Desjadon spoke in rather more positive terms about the fund, arguing it serves a “valuable purpose in stabilising the rate structure in Florida”. Addressing whether it represents a long-term backstop for the market, he said that it would help create a “glide path to a longterm solution. Knee-jerk changes in the Florida cat bond market have the potential to result in severe consequences. If the cat fund were to shrink capacity by a third it would place enormous demand on the private reinsurance market”.
“The reinsurance market would likely respond, but it would respond with pricy capital and that would put Florida companies in a precarious position. Even if those companies were able to respond quickly, it would mean rapid and dramatic rate increases which would further exacerbate the issue of affordability.” Desjadon warned against the immediate withdrawal of the fund, stating that such a move would inflict grievous damage on the Florida ecosystem. Rather, a long-term shift towards its eventual departure would be the best solution for Florida and its insurers.
Turning to the state-backed insurer, Citizens, Barrales said that as the largest insurance writer in the state—with around a 21 percent share of the market—it is not only a competitor to private domestic insurers, but also competes for reinsurance capacity. In the primary market Citizens’ involvement has meant that it is “simply not a level playing field” and while recent steps have been taken to downsize the state insurer they are only “baby steps, which need to be reinforced with further action to help create a vibrant private insurance market able to buy private reinsurance”.
Asked if the removal of Citizens and the cat fund would present potentially systemic risk to the market, Barrales said that the maturity of the insurance and reinsurance industry and the growing provision of private capital market capacity would mean that a major market dislocation such as that which prompted the creation of the FHCF and Citizens was unlikely to now occur. With the industry able to maintain steady levels of supply and smoother price movement as a result, there seems little need for the backing of the state, he concluded.
Florida, Bermuda, insurance, reinsurance, hurricane risk