First and foremost, as Hurricane Irma unfolds, S&P Global Ratings continues to hope for the safety and wellbeing of the many people who will be affected by this devastating and potentially deadly event.
The re/insurance sector is still tallying the losses from last week but there is no respite as Hurricane Irma is shaping up to cause a far greater hit to lives and homes than Hurricane Harvey. Although the strength and direction of the hurricane could change over the next few days, the initial forecast is projecting Hurricane Irma to hit Florida over the weekend. With wind speed of at least 100 miles per hour, should Hurricane Irma make a landfall, the resulting damage could be substantial. The last big hurricane to hit Florida was Hurricane Andrew in August 1992, which led to $27.3 billion of insured losses (in 2017 dollars) according to the Insurance Information Institute.
The hurricane's projected path will take it to the Caribbean islands, near or over Cuba, then toward the U.S. The exact impact on Florida and the extent of damage will depend on the path it charts and where it lands, so it is too early to estimate the losses. However, according to AIR Worldwide, if a Category 5, Andrew-like hurricane were to strike just south of Miami and a little north of the city of Homestead, the total insured losses for Florida could reach upward of $130 billion. In that scenario, S&P Global Ratings is likely to view Hurricane Irma as a capital event for the re/insurance sector, in contrast to Hurricane Harvey, which it assessed as an earnings event.
Florida is one of the peak wind exposure zones for many re/insurers, and third-party capital is significantly involved. Post-Hurricane Andrew, the primary insurers have undertaken de-risking in large part through the use of reinsurance. Therefore, we believe reinsurers rather than primary insurers will bear the brunt of covered losses. This is different from our view on Hurricane Harvey, where we estimate primary insurers will retain most of the losses.
With the re/insurers earnings already coping with Hurricane Harvey-related losses, capital will potentially take a hit. And although the ratings are supported by record-high surplus levels, we would consider a company that experiences large losses that translate into capital erosion as an outlier that could be subject to a negative rating action. Nevertheless, the extent of rating actions will depend on re/insurers' capital buffers for the current ratings, reinsurers' earnings power over the next two years, and management's intent and plan to replenish the capital.
While pricing in affected regions and lines of business is expected to increase as re/insurers look to recoup the losses, the impact on global reinsurance pricing is uncertain and will be influenced by the severity of losses and subsequent availability of reinsurance capacity.
Wind And Storm Surge To Likely Drive The Losses
Wind and storm surge are likely to be the primary cause for losses rather than flood-related damage as is the case for Hurricane Harvey, and the most affected line will be residential property. As a result, we expect the difference between insured losses and economic losses to be narrower. Furthermore, we do not expect the auto line to face a significant exposure to losses because of Irma. During Hurricane Harvey, most residents didn't evacuate and thus many vehicles remained in place exposing insurers to significant flood losses that are covered under comprehensive automobile policy. Florida has already begun ordering coastal evacuations in preparation of potential landfall Sunday, which we believe should reduce auto losses.
Reinsurers Might End Up Holding The Bag
Reinsurers will have a significant exposure to potential damages arising from Hurricane Irma, unlike in the case of Hurricane Harvey. Florida wind is considered a peak zone for many reinsurers. These reinsurers provide significant coverage to Citizens Property Insurance Corp. (a not-for-profit government entity, which is the primary insurer of last resort), and to the Florida Hurricane Catastrophe Fund (FHCF).
The global reinsurers entered 2017 with a robust capital adequacy, which has been one pillar of strength for the sector. Global reinsurance capital reached a record $605 billion as of March 31, 2017, based on an Aon Benfield report. Capital strength has provided a safe harbor in an otherwise turbulent environment. At the 'A' (strong) capital assessment level, we estimate that capital redundancies of 20 consolidated key reinsurers at year-end 2016 were about $41.6 billion. We believe, on a stand-alone basis, that Hurricane Irma will likely be an earnings event for the reinsurance sector if it turns out to be a 1-in-50-year-or-lower return period event. However, it will likely become a capital event for the industry if it is a 1-in-100-year event. And this does not include the additional reinsured losses from Hurricane Harvey, which we view as an earnings event. Furthermore, these 20 reinsurers have generated about $18 billion in reported net income in 2016. Therefore, we believe year-to-date reinsurers' earnings will absorb Hurricane Harvey's losses and soften the blow from Hurricane Irma.
Could Irma Test The Catastrophe Bond Market?
Ever since the first catastrophe bond was issued, the question "How would the market react to a major event?" has loomed, and Hurricane Irma could very well be that event. We have identified a list of the bonds we currently rate that have substantial exposure in areas that are now in Irma's path (see "Hurricane Irma Poses A Risk To 13 Rated Catastrophe Bonds," published Sept. 7, 2017, on RatingsDirect). If the losses come in on the high end of the estimates, we would expect one or more of the per-occurrence bonds to incur a principal reduction. Based on Irma's current path and wind speed projections, we expect the covered losses related to the aggregate bonds to erode a portion of the retention layer and potentially result in downgrades. However, we will not be taking any rating actions on the bonds until we observe the damage after Irma makes landfall, and most likely not until we receive loss estimates from the issuers. As to what happens post-Irma, even if bonds were to suffer principal reductions, we expect most investors would remain as periodic losses are to be expected so one event, even a major one, should not result in a mass exodus.
Past Actions May Limit Impact To Large Primary Insurers
We expect losses for primary insurers to be contained as reinsurers take the brunt. Post-Hurricane Andrew (in 1992), the primary insurers underwent a de-risking strategy. Larger insurers reduced their gross exposure to Floridian residential property with the top 10 insurers accounting for more than half of the overall market share of residential property at that time. This was followed up by additional de-risking in the post-2004 and 2005 hurricane seasons (including hurricanes Katrina, Rita, and Wilma). As a result, the top 10 insurers now account for about one-fifth of the market--a considerable reduction. In addition, these insurers leveraged reinsurance while also relying on the FHCF to reduce its footprint in the state. Along with Citizens, smaller mono-state and regional players (not rated by S&P Global Ratings) helped fill the void left by the larger players. However, these insurers don't have the balance-sheet fortitude to bear much risk, are often dependent on reinsurance leverage, and would need to tap the broader markets to replenish their capital structures. With reinsurers holding excess capital and continued inflow of third-party capital that views property-catastrophe as diversifying risk, primary insurers have had access to ample reinsurance capacity to lay off risk. We have observed insurers raise their reinsurance utilization in the past five years, with some buying higher layers for greater severity protection. Therefore, the resultant impact for primary insurers will be limited to their net retention layers, with the bulk of the insured losses being transferred to reinsurers, the state catastrophe fund, catastrophe bonds, and similar structures.
In aggregate, the U.S. property and casualty insurance sector generated an operating gain of $43 billion in 2016, on a U.S. statutory basis, primarily driven by investment income. Statutory surplus was $701 billion, an all-time high because the industry has benefitted from a relatively benign catastrophe environment in the past few years. Therefore, on a consolidated basis, we believe this sector is in a good position to deal with the event. However, the effect on individual companies will vary. For both insurers dealing with Hurricane Harvey and geographically concentrated players, losses from Hurricane Irma will likely eat through earnings and could potentially hit their capital base. While large, national primary players have geographic and product diversification to absorb (partial) losses and make up through future earnings, regional and local players (which are greater in number in Florida) could face a significant hit to their capital. Consequently, we could consider taking negative rating actions on insurers where we believe capital levels might decline in excess of 10% below our base-case assumptions and are unlikely to recover in the next year or two based on earnings capabilities and management's strategy to replenish capital levels.
Citizens Property Insurance Corp. And Florida Hurricane Catastrophe Fund Provide Relief
Both Citizens and FHCF have sufficient resources to provide relief to the sector and policyholders in case of a large event.
A lack of severe storm activity since 2005 has translated into increased reserves and enhanced liquidity for Citizens. There is about $13.3 billion in resources available from surplus, reinsurance, FCHF reimbursement, and pre-event bonds. In addition, Citizens has the ability to levy emergency assessments on a direct written premium assessment base that has steadily increased to almost $44 billion in 2016. Resources on hand and authority for emergency assessment levy, coupled with a steady reduction in policies, position Citizens well financially to cover most recently estimated net losses of about $10.8 billion for combined coastal and the personal lines account /commercial lines account (PLA/CLA) for a 1-in-250-year storm event, or $6.6 billion for a 1-in-100-year storm.
FHCF is a state trust fund in which Florida-authorized property insurers are required to participate. The fund provides reimbursements to insurers for a portion of their catastrophic hurricane losses. The maximum potential reimbursement to the insurance industry is capped by state statute, which is currently $17 billion. Given the size of potential losses from Irma, FHCF could reach the maximum limit on reimbursements. However, it currently has more than $17 billion of current resources on hand in the form of accumulated reserves, pre-event bonds, and reinsurance. FHCF could use a portion of pre-event bond proceeds, issue post-event bonds, and/or levy emergency assessments to help pay claims or rebuild its claims-paying capacity for the subsequent hurricane season. We note that FHCF has the ability to levy an emergency assessment of up to 6% for a single year and that the assessment base has grown since 2010 to a sizable $43.7 billion in 2016.
Irma Could Further Test The Resolve Of The National Flood Insurance Program
With Florida accounting for about 35% of the National Flood Insurance Program's (NFIP) policies-in-force, Hurricane Irma will not leave the NFIP unscathed. However, considering that the bulk of losses are expected to be driven by wind damage associated with the storm, NFIP will likely be spared the scale of damage that came its way from Harvey. Hurricane Harvey likely left the NFIP's funding capacity, both reinsurance and borrowing authority, exhausted. So any losses associated with Irma will push the NFIP further into the red. Pre-Harvey, the program was about $25 billion in debt and that debt will only increase post-Harvey and post-Irma. The recent events will only serve to underline the ongoing debate on social policy perspectives and participation of private capital, which was set to come to a head on Sept. 30, when the NFIP was set to expire. However, as part of the Harvey aid package, lawmakers are proposing a three-month extension until Dec. 8, to protect insureds affected by these events. And although there are still a number of hurdles to clear before the deal can be finalized, we expect it will be signed into law.
Is This The Turnaround For Global Reinsurance Pricing?
The industry will be watching with bated breath for how this event will sway pricing. Prices will increase for affected regions and lines of business as re/insurers look to recoup the cumulative losses from hurricanes Harvey and Irma over next few years. Pricing will also be influenced by likely increases in reinsurance/retrocession costs and the extent of availability of affordable reinsurance capacity post-event. However, we don't expect Hurricane Irma, in and of itself, to drive-up premium rates for primary business nationally in any material way. A second-order effect can drive up pricing nationally because of development in the reinsurance space as highlighted below.
Whether Hurricane Irma will have any appreciable impact on global reinsurance pricing is uncertain and will be influenced in large part by the severity of losses and the effect on availability of third-party capital, among other factors. Some alternative capital providers might finally come to realize that the property-catastrophe business has significant tail risk and can result in a total loss of capital. Significant contraction of third-party capital could harden pricing globally although this could be partially offset by ample capacity that can be deployed post-event by the reinsurance sector or even by third-party capital that is still comfortable with this type of risk.