For most people in the financial world, mid to late August is a time of absences, unreturned calls and general lassitude. Not so the catastrophe end of the insurance market. Menacing mid-Atlantic storm tracks are on the screens, markets are watched intently and critical reports are issued.

We are coming in to the peak of the “named storm” season in the Atlantic Basin, and that is when the insurance underwriters’ profits are made or lost. It has been nearly a year since the “HIM” storms — hurricanes Harvey, Irma and Maria — lashed Florida and the Caribbean.

A non-specialist might have thought that three catastrophic (insured) events coming in rapid succession would lead to some sort of market crisis, but no. While doing their best to stay within the bounds of good taste by putting on long faces, the catastrophe reinsurance people clearly hoped that stagnant prices would be goosed up by a squeeze in outside capital and increased demand.

Almost. A year on, the catastrophe business has attracted a lot of new capital in to the business. According to Artemis of Bermuda, catastrophe bonds issuance have increased $11bn so far in 2018 to a total of $36bn outstanding. Other forms of insurance linked securities (ILS) also gained market share, but after a strong January renewal season, the price increases have not met the giddy post-storm expectations

In recent years the high margin end of catastrophe insurance has been dominated by “non-traditional” ILS. These tap the yield-desperate bond markets, which like the relative high coupons of ILS, in particular cat bonds.

While there is the potential for catastrophic insurable loss almost anywhere in the world, the ILS and cat bond markets are centred on “US Wind”. By far the biggest single “peril” in that category are hurricanes hitting Florida.

At least half, and perhaps as much as 70 per cent, of the catastrophe reinsurance market’s capital is exposed to Florida. There are plenty of catastrophes elsewhere in the world, but Florida has a large number of structures for moneyed people whose exposure to storms is modellable.

Japanese or Californian earthquakes are also pretty bad, but their occurrence is much harder to predict. Weather patterns over a one to three-year period are easier. Climate changes over much longer periods of time. While climate change components are included in storm frequency and severity modelling, the catastrophe insurance business does not ascribe year to year increases or decreases in tropical storm losses to short-term climate policies.

The chronic profit problem for the reinsurance industry has less to do with climate change and a lot to do with being overcapitalised. It is too easy for investors to throw a lot of money at cat bonds in return for an extra couple of hundred basis points of margin over the Treasury or AA corporate curve.

The insurance industry has adapted to this problem in several ways. Some, such as Swiss Re, are intermediating between investors and the cat bond market.

Axa, the French insurance company, has a different approach. This year it acquired XL Group, a large Bermuda-based reinsurer. The combined company is now rapidly selling off its catastrophe risk to those eager capital markets investors. Maybe Axa will be proven wrong. Or perhaps underwriting catastrophic losses is not really free money after all.

One reason to hesitate before committing capital to catastrophe risk underwriting is the inventiveness of Florida lawyers. While cat risk prices went up during the January underwriting season, and cat bond investors threw more chips on the table, there has been a disturbing trend to what is called “reserve creep”.

Reserve creep happens when you, the reinsurer, have modelled your expected losses based on storms’ frequency and intensity, and on the value of insured property. Homeowners or auto owners report losses, their losses are reviewed by claims adjusters, paid, and then some of those losses are covered by reinsurance. Sounds reasonable.

Florida, though, has what I understand to be a unique wrinkle in its laws on insurance covered, called “assignment of benefits”. If you have suffered storm damage in Florida, you can sell, or assign, your future insurance proceeds to someone else. Such as a Florida law firm.

You have probably never heard of AOB. If, however, you are driving to the liquor store in a strip mall in central Florida, you will pass law firm billboards that suggest you should sell your claim instead of collecting it and repairing your house or car.

So those reinsurers who believed in models based on material reality have come to realise that Florida lawyers have a different, more remunerative concept. The reinsurers have to gradually increase their reserves as claims fill with noxious gas in the tropical heat.

Heritage Insurance Holdings, which has been a fast-growing Florida firm, has had to increase its loss reserves for last year’s Hurricane Irma from $388m in November to between $700m and $800m in recent weeks.

Maybe Axa/XL are right to consider passing up on these opportunities. Maybe cat bond buyers should question their apparent good fortune.


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