There’s more than one Florida state agency looking to tap into growing demand from capital markets investors for insurance-linked securities.
Citizens Property Insurance, which provides insurance to Florida property owners, pioneered pitting capital-market investors against traditional reinsurers in 2012, when it completed the first of its enormously successful Everglades Re deals. The $750 million transaction, upped from an initial $250 million, was launched alongside a reinsurance deal that priced several percentage points below a similar policy done the year before.
And in May of this year, Citizens inked a $1.5 billion cat bond holding the same single-B rating, and it fetched a coupon of 7.5%, more than 10 percentage points below the deal two years ago.
The Florida Hurricane Catastrophe Fund, which reimburses insurers operating in the state for a portion of their catastrophic hurricane losses, has also been contemplating insurance-linked securities as a means of transferring risk as well as fueling competition among potential reinsurers.
“We’ll definitely be looking into it, and we’ll definitely be monitoring the markets, and if pricing remains competitive and terms continue to liberalize, we would be inclined to do a deal,” Jack Nicholson, chief operating officer of the fund, said in an interview with ASR.
Florida is typically the most hurricane-prone state, but after eight years without a storm making landfall, investors are lining up for exposure. For now, the FHCF funds reimbursements by issuing taxable bonds with maturities up to seven years in anticipation of catastrophic events. This is meant to provide liquidity while the agency issues tax-exempt debt with much longer terms after a catastrophic storm to fund payouts.
Yet the agency generated significant interest from Wall Street and traditional reinsurers last fall when it put out feelers for a risk-transfer transaction. ILS transactions place the principal in a trust, so when the securities are triggered it can be accessed by the issuer to cover losses, while traditional reinsurance covers a portion of an insurer’s claims in exchange for a portion of its insurance premiums.
“There were a number of reinsurers anxious to get in on our deal, and I had people say they may even be willing to take [pricing] below market, just to get the business on their books, Nicholson said.
He said FHCF “would hope to get similar pricing” to Everglades Re’s latest offering.
Reinsurers have slashed their premiums over the last few years, and even though yields on ILS transactions have dropped markedly over that period, the base of investors has continued to broaden to include money managers, pension funds and other mainstream institutions.
So why didn’t FHCF bite? Despite the increasingly attractive terms and pricing, hurdles remain, even if they’re lessening. For one, Nicholson said, hurricane-related claims can take years to settle—Hurricane Hugo in 1989 took 12 years to settle, and Hurricane Andrew in 1992 took 10 years. ILS investors, on the other hand, have traditionally wanted out of their exposures in two years or less, creating a mismatch in terms of when funding is available to meet claims.
“There’s a lot of risk there, particularly with commercial exposures, which can take a long time to settle, and the potential for re-opened claims,” Nicholson said, adding that more recent ILS deals provide greater flexibility in terms of settlement periods.
A spokesman at Willis Capital Markets & Advisory (WCMA), a unit of insurance broker Willis Group, confirmed that “commutation provisions in cat bonds have become more flexible, allowing for longer development periods where appropriate.”
In addition, investors in catastrophe bonds or collateralized reinsurance, which is reinsurance that’s fully collateralized and typically bought by investors, were once much more averse to risk and demanded low probabilities that bond payouts would be triggered. Where expected loss probabilities were once in the range of 0.4%, now they can be as high as 5% or more, Nicholson said.
In fact, more than a quarter of the cat bond volume carries an expected loss probability of 2.51% or greater, according to the WCMA database.
The combination of more liberal terms and investors’ higher risk tolerance has enabled ILS to “compete directly with private reinsurance, and that’s made it much more attractive,” Nicholson said.
He added, however, that he harbors other concerns. For example, there’s never been a hurricane-related loss in Florida that triggered a cat bond, so it’s unclear how claims would play out legally, since the bonds are covered by securities law that protects investors while reinsurance is covered by insurance law protecting policy holders.
“An investment banker may be able to explain why this is not a problem, but it makes sense that it could be an issue, and you won’t know until after the fact,” Nicholson said.
There are also political challenges. Although legislators are keen to reduce the fund’s claims-paying capacity and therefore the risk to taxpayers, transferring a portion of that risk to the private market has run into a “perception” stumbling block, Nicholson said, because it costs more than issuing municipal bonds and such costs may be passed through to policy holders. He cited estimates suggesting ILS would increase the rate FHCF charges insurers by 0.5%, but said the premiums that insurers pay for reinsurance are anticipated to drop by 15% to 20% this year. This would more than offset a rise in FHCF’s premiums should it issue insurance-linked securities.
“The FHCF has rates that are one third to half the level of private reinsurance, and to make the FHCF work on a sound financial basis, it is important that the FHCF be able to handle large events in a timely fashion meaning that we may need liquidity,” Nicholson said.
And if this year’s hurricane season turns out to be mild, leaving the fund untouched, it may be even harder to increase capacity by transferring part of that risk to the private market. Eight hurricane-free years have allowed the FHCF to accumulate cash reserves for the 2014 hurricane season projected to be about $11 billion at calendar year end, plus another $2 billion in liquidity from other sources.
If this streak ends with a large hurricane event that exhausts the FHCF’s cash resources, it will be obligated to issue revenue bonds to fund the difference in its $17 billion of potential obligations.
“It’s harder to argue you need it to maintain your long-term viability than your short-term viability,” Nicholson said. “In the short-term, we’re in great shape, and if we don’t have a hurricane this coming season we’ll be in fantastic shape.”