Hurricane Matthew's close encounter (so far) with the Florida coastline, and as Georgia and South Carolina are also set to feel the hurricane's force, could be the first real test for insurance, reinsurance and insurance-linked securities (ILS) players in recent years, according to rating agencies and equity analysts.
Click to enlargeDespite the fact the outlook is looking slightly better and currently suggests the potential for a major loss may have lessened somewhat, hurricane Matthew is still a storm that could threaten the solvency of some re/insurers and impact some ILS funds or investment vehicles and there is some uncertainty in the forecast path still.
120mph hurricane Matthew continues to hug the coastline of Florida, refusing to make landfall but also not moving away. The eye of the hurricane is just 35 miles from land, but that currently makes all the difference to the wind speed coastal areas experience.
Storm surge remains an issue and coastal wind damage will also be a factor as well, plus rainfall forecasts suggest extreme levels for Georgia and the Carolinas. So even if Matthew does remain just offshore for the duration of its pass of Florida and the southeast, it still has the potential to create losses. It's just very uncertain how much at this time.
But risks remain to the industry, as a significant proportion of Florida's primary insurers have likely never experienced a storm like this, with so many being relatively recently established and launched in order to take-out policies from Florida Citizens.
Chris Grimes of Fitch Ratings highlighted this fact, saying; "Hurricane Matthew will test Florida's previously untested homeowner specialist insurers if there are significantly sizable losses."
If hurricane Matthew continues to track just offshore the loss, while still perhaps sizable, may not be as significant as it could have been, but still some primary insurers will have their claims management processes and financial strength tested to a degree whatever the magnitude of the financial impact.
Meanwhile A.M. Best highlighted that it is the dedicated Florida property insurance specialists that will be most at risk from this hurricane, saying that; "A.M. Best does not anticipate taking a significant number of rating actions associated with Hurricane Matthew," and adding that rated companies with broadly diversified businesses are "In a much stronger position to absorb this catastrophic loss than are dedicated Florida property writers."
Ben Cohen, an analyst at Cannacord Genuity said that there are "material risks" to some of the Lloyd's re/insurers from hurricane Matthew, with an industry loss of around $20 billion (which it was said yesterday there could be a 40% chance of) perhaps leading to a "material impact to profits for the Lloyd's insurers."
Analysts at KBW led by Meyer Shields agreed with our assessment that despite the fact Matthew could cause a reasonably large industry loss, the chances of a spike in reinsurance pricing afterwards is unlikely.
KBW wrote; "Although we expect Matthew to produce meaningful losses (RMS estimates losses approx. $20b), we still don't expect it to drive meaningful rate increases."
KBW also favors primary insurers with more geographic diversification, but adds that it does believe the sell-off in Florida direct writers stocks was over done, adding that overreaction could create a buying opportunity for investors.
The same goes for reinsurance firms, KBW said, as those with more retrocession in place may also offer buying opportunities to shareholders after share prices declined perhaps more than warranted for the storm and their robust capital bases.
But perhaps having sensed the continued uncertainty in the forecast, the analysts at KBW noted; "It appears clear that Matthew will produce significant losses, and the question now becomes how large."
"We doubt that Matthew will cause enough losses to materially raise pricing, although property-cat reinsurance rates could finally find a floor and flatten out at the upcoming January-1 renewals if the reinsurers experience high losses," KBW's analysts explained.
And suggesting that some reinsurers could face erosion of their financial strength, "Since (re)insurers will likely experience losses without a large uplift in rates, we favor geographically diversified names… If Matthew does cause significant reinsurance losses, impacted carriers could face the double downside of a 4Q16 earnings hit and smaller 4Q16 share repurchases in 4Q16 as excess capital is washed away," they continued.
Analysts at J.P. Morgan highlight that the big four European reinsurers would be particularly exposed to a major loss, with Swiss Re (OTCPK:SSREY) having the largest concentration of U.S. property catastrophe exposure of the four.
"We would expect around 50% of insured losses to be borne by the reinsurance market (potentially higher in a very large event), and we typically assume market shares of ~10% for Swiss Re and Munich Re, ~6% for Hannover Re (OTCPK:HVRRY), and ~3% for SCOR. We note that both Hannover Re and SCOR are likely to have more retrocession cover and, therefore, could see lower net losses when compared to their gross exposure (we assume 75% retained vs. 90% for Swiss and Munich)," they explained.
One issue reinsurers could face, if indeed Matthew's losses turn out to be on the higher side, is a complete erosion of their catastrophe budgets for this year. A loss in the $10 billion to $15 billion range could be enough to wipe out the budgets for some reinsurers, J.P. Morgan analysts note.
But, cautiously, the analysts explain that "Any loss would likely be an earnings event rather than one that causes a more meaningful hit to capital in the sector," which again plays to the expectation that this won't move rates.
Highlighting just how strong reinsurance capital positions are, Deutsche Bank analysts said that it could take a $40 billion plus loss for capital to be eroded so much that the big reinsurers stop their share buybacks. Again, that suggests no let up on pricing as capital will remain in excess.
Standard & Poor's highlighted the test that reinsurance firms face with hurricane Matthew, but noted that the effect on reinsurers capital adequacy will depend on the severity of the storm's impact.
"For reinsurers, Hurricane Matthew represents a real test of their exposure," commented S&P Global Ratings credit analyst Johannes Bender.
S&P said that if losses from hurricane Matthew matched those of a 1-in-100-year loss event, some peer groups in the re/insurance industry, and even specific reinsurers, would be harder hit.
Of S&P's 21 rated reinsurers the agency anticipate up to five as being likely to report a loss and experience some level of capital deterioration if a 1-in-50-year catastrophe scenario came to pass with Matthew.
S&P provides useful insight into how hurricane Matthew could impact the reinsurance industry, depending on its severity:
- Hurricane Matthew's impact has the potential to erode some of the global reinsurance sector's excess capital, but we do not expect the sector's overall capital position to deteriorate below the 'AAA' level, even if Matthew proves to be a much more severe loss event than Hurricane Katrina, with a return period of 100 years.
- If Matthew proves to be at least a 1-in-20-year loss event, we could see earnings, capital adequacy, and ratings coming under pressure at some of the more exposed reinsurers.
- For the London market players and the midsized global reinsurers subgroups, capital adequacy is likely to change by one category on an aggregate basis if Matthew is larger than a 1-in-20-year loss event.
- If Matthew is a 1-in-50-year loss event, the sector's pretax profit would fall by an average of about 95%, the combined ratio (a ratio above 100% indicates that incurred losses and operating expenses exceed premiums received) could deteriorate by 13 percentage points, and about one quarter of rated reinsurers would likely suffer a net operating loss for the year.
"We expect resilience to extreme catastrophe events to vary across the different peer groups we follow within the overall reinsurance industry," S&P noted, explaining that the impact will depend on reinsurers strategies, exposures and also use of retrocession.
"In general, for the large global reinsurers, the Bermudians and the property catastrophe and short-tail writers' capital adequacy, although reduced, would remain redundant, in aggregate, at the 'AAA' level," the rating agency said.
As ever it is the specialist property catastrophe players that are considered most at risk.
S&P highlighted that; "We anticipate that property catastrophe and short-tail specialists will experience the most severe effect on earnings. In aggregate, this peer group would likely suffer a net operating loss if Matthew has a return period of 50 years or more. In such a case, we forecast that 24% of the total reinsurers we rate would report a net loss."
But of course reinsurers are not the only property catastrophe specialists. The insurance-linked securities (ILS) market and its fund managers are largely focused on catastrophe risks still, despite the markets gradual expansion into new lines of business.
Grimes of Fitch Ratings highlighted that any sizable loss could impact the ILS market as well as reinsurers.
"With heavy reliance on reinsurance in the Florida property insurance market, traditional and collateralized reinsurance and catastrophe bond markets could also see substantial losses," he said.
If Matthew remains offshore it is hard to imagine any catastrophe bonds coming under significant pressure. But other private ILS, collateralized reinsurance and sidecar vehicles could, if losses are sufficient for direct Florida writers to call on their reinsurance arrangements.
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