10 September 2016News

Cat in box structure can drive innovation and growth

The global reinsurance industry has struggled for growth in recent years, Bermuda companies as much as any. Without growth and the movement into new risks, a soft market will continue and profit margins become ever more elusive.

“It’s no secret that the global reinsurance industry needs to source more original risk. A sustained focus on established markets leads to the myopic process of shaving fractions of a basis point off each transaction, generally with the modest hope of nudging returns higher,” says Tom Johansmeyer, assistant vice president, reinsurance services, marketing at ISO/Verisk Insurance Solutions.

“But you just can’t cut your way to real growth. It takes new markets to drive the sustained profitable growth that C-suites around the world crave.”

"Refreshing the cat-in-a-box structure with Wood Mackenzie data has the potential to turn a small market into a large one, bringing a new way to grow shareholder value in an industry awash in capital.”

Johansmeyer believes that offshore energy could represent a significant original risk opportunity. He notes that although the re/insurance industry talks often of the abundant—or even excess—capacity available, there doesn’t seem to be enough to meet the needs of the offshore energy market.

Public reports put the sector at only $7.5 billion, compared with an aggregate physical value of up to $115 billion (excluding platforms located in state waters), according to data from Verisk Analytics subsidiary Wood Mackenzie.

“Pair this with the fact that original insureds are struggling against economic headwinds and believe they can absorb losses with their balance sheets, and the challenge becomes one of both supply and demand,” Johansmeyer says.

Of course, nothing’s ever that simple, he stresses. While there seems to be appetite for these risks on both sides of the equation, there are historic problems that must be overcome for it to flourish.

“It’s become clear through a wide range of conversations across the industry that there’s plenty of appetite to write offshore energy business. And there’s a sense that demand for additional capacity does exist at every step in the risk and capital supply chain, although it would begin modestly,” Johansmeyer says.

“The primary barrier to bringing this new risk to market has been the structures historically used in industry loss warranties (ILWs). Traditional approaches to alternative forms of protection aren’t sufficient to grow the pie, leaving a protection gap that only innovation can fill.”

Industry loss index

He believes that a useful first step would be to enhance the ‘cat-in-a-box’ approach. He notes that the cat-in-a-box structure is fairly straightforward. It uses a predefined risk area and triggers when an event of a certain magnitude occurs within it—for example, a Category 3 hurricane passing through a specific part of the Gulf of Mexico.

But what’s missing from this approach is something closer to industrywide insured loss data, he says.

“Absent an industry loss aggregation platform—such as Property Claim Services (PCS) for property catastrophe risk—payout factors can be difficult to calculate. While ILW trading using cat-in-a-box triggers has helped offshore energy insureds, insurers and reinsurers gain access to capacity, the basis risk involved has led only to an incremental impact—not a transformative one.”

Johansmeyer says the solution, at least in the near term, could be to use industrywide offshore energy exposure data to approximate the impact of an event in the box. Specifically, filling the box with offshore energy platform valuation data from Wood Mackenzie is beginning to look like a viable alternative, he says. While it may not be a true industry loss index, the data should serve as a sufficient proxy because it provides an industrywide loss equivalent.

Wood Mackenzie is a global provider of data analytics and commercial intelligence for the energy, chemicals, and metals and mining industries. With more than 40 years of history, it provides objective and integrated analysis across the global natural resources value chain, including for assets, companies, and markets.

“With this market intelligence, which includes 100 percent market coverage for the Gulf of Mexico and the North Sea, one could aggregate the values in the risk area and calculate the physical damage and business interruption impact using Wood Mackenzie historical data and a relevant factor to translate actual loss into insured loss,” Johansmeyer says.

“Putting the industrywide physical damage and business interruption estimates together—a process that could be completed in less than 90 days—the result is a total property catastrophe loss for the assets in the box, which approximates an industry insured loss estimate and results in a much more robust ILW trigger.

“There are many hurdles to clear when trying to source original risk from the offshore energy market. But the absence of relevant risk transfer tools shouldn’t be one of them. Refreshing the cat-in-a-box structure with Wood Mackenzie data has the potential to turn a small market into a large one, bringing a new way to grow shareholder value in an industry awash in capital.”