Reflecting just how well capitalised the reinsurance industry is, analysts at Morgan Stanley said today that they believe that even the aggregate industry losses from hurricane Irma and hurricane Harvey combined could still only be an earnings event for the sector, rather than a capital event.
Hurricane Harvey alone was always assumed as an earnings event, given the weighting towards flood exposures and the fact primary insurers are set to retain a lot of the losses.
But for category 5 hurricane Irma, as it barrels towards Florida with 185 mph winds, the expectation is that reinsurers will take a much greater proportion of any eventual losses, as Florida primary insurers tend to use plentiful reinsurance and the U.S. nationwide players (which tend to have higher retentions) are in some cases less exposed there.
Additionally, the impact of a second hurricane in such quick succession will bring into question some primary insurers reinsurance programs ability to withstand frequency losses, as well as the severity of a single event. This could also be a factor in certain retrocession arrangements.
But despite the industry loss estimates, based on scenarios, for hurricane Irma ranging from around $15 billion to $100 billion or greater, the analysts at Morgan Stanley say that, at least for the big four European reinsurers, the aggregate impact of the two hurricanes will likely remain an earnings event.
"We expect continued pressure on reinsurers but based on early potential industry loss indications, believe Harvey and Irma combined will be an earnings rather than capital event," analysts Nadine van der Meulen and Jonathan Denham wrote in the report.
For their analysis they compared Irma to hurricane Katrina (~$80 billion), so only the biggest loss in insurance and reinsurance history, then add it to a proxy for hurricane Harvey for which they use Ike ($22 billion), then add the two together and looked at how it will impact the largest reinsurance players.
The analysts estimate that the two hurricane losses combined would cause roughly a 70% hit to 2017 earnings, Swiss Re (OTCPK:SSREY) 74%, Munich Re 78%, Hannover Re (OTCPK:HVRRF) 61%, and a roughly 6-8% hit to 2017 equity for all three.
That's manageable, the analysts believe, so making the losses an earnings event rather than capital.
They explain; "Most cat budgets could be absorbed but, based on these assumptions, there would not be a capital impact and we would not expect to see base dividends impacted."
Additionally, there could be opportunities for these major rensurers to deploy capital at higher rates following the events, which would support their future earnings.
It will be interesting to watch the fall-out, if hurricane Irma does become a second landfalling major storm in such quick succession, it could affect the property catastrophe specialist reinsurers much worse than the major European players.
How the market dynamic plays out after that would be intriguing, as the large European players could find they have capital to deploy much more quickly than the likes of the Bermudian companies. Additionally, the ILS fund market may find some of the larger managers can recapitalise quickly as well, so capacity could remain abundant, although not for the smaller reinsurers that are hit hardest.
Some of the smaller reinsurers would be hoping that their third-party capital vehicles could recapitalise faster, but after an event institutional investors may become more choosy about where their money sits and if any smaller reinsurers are hit hard they could find it more difficult to attract investors to pour money into their sidecars and collateralized vehicles.
The dynamic that will play out following a major industry loss will be fascinating to watch, but the overall effect could be one of ensuring that it remains an earnings event for the largest, but could be a major capital drain on some of the smallest, thus even having the potential to separate the market tiers even further.
For large ILS funds and those with post-event structures and capital arrangements already in place, there could be opportunities to increase share and become even more relevant for cedents, if capital continuity can be achieved to replace coverage for clients.
Interestingly, the analysts also suggest that some of the bigger reinsurers could forego capital returns in order to deploy it into any more attractive opportunities that emerge, so the capital inflow into reinsurance could actually accelerate, at a time when many firms are hurting.
Could we see an end-result where the largest reinsurers in the world and the ILS market take more share, while smaller and more marginalised reinsurers find their capital depleted and opportunities harder to secure as a result? It's possible.
Before any of that becomes clear though, the impacts of hurricane Irma will need to be clearer. The storm is likely to have caused significant loss of life in the Caribbean islands that were closest to its path and uncertainty remains in the eventual track Irma will take towards Florida.
Losses to the Caribbean islands could be partly covered by their CCRIF policies, where they have them, with insurance and reinsurance supporting some of the rest of the impact, however there is likely to be a much more significant protection gap here than there will in the United States, should Irma make landfall there.
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