Thoughts on Irene

Given the pace of events, I’m tweeting fairly regularly on Hurricane Irene. (See the column near the top left of this page, or check out http://twitter.com/#!/jimlynch9999.) All week I’ve tried to keep up-to-date on the path and intensity of this one.

• NOAA puts VA to NJ on hurricane watch: http://ow.ly/6d4rj || #Irene likely to hit NJ dead-on as Cat 1 or severe TS – map: http://ow.ly/6d4wx

I’m concerned. Right now, the heart of the tropical storm looks like it will pass just west of my home (Montclair, NJ).

But I’m not freaked because a storm is bearing down. I’ve been through hurricanes before (Andrew).

I’m concerned because, as of now (10 p.m. Thursday), NOAA forecasts a Cat 1 hit on New Jersey, a state that hasn’t been hit by a hurricane since, I think, 1903. There are a lot of old trees throughout the state. When hurricanes go far inland, those older trees can’t handle the winds. They fall and damage a lot of homes, especially in wealthy areas – rich people like big old trees around. If a lot of them topple onto power lines, there could be astounding power outages, triggering business interruption coverage.
I’d love to be wrong, but I sense a lot of damage and another multibillion-dollar event.

• #Irene could be multibillion-dollar insurance event http://ow.ly/6dbmA || Similar to Floyd ($3.5B) and Jeanne ($4.15B).

But I think it could be much, much worse than either of those two.

Would love to be wrong.

 

 

East Coast quake: Some facts

• Epicenter near Charlottesville VA, 5.9 with a depth of “more than three miles.” That’s the worst quake since 1897 in Virginia, not as bad as the 6.3 in New Zealand in February and far short of the 9.0 quake in Japan. (Each increase of a single point is an increase of about 30-fold in shaking intensity.)
• Initial reports – minimal damage at Charlottesville and Richmond. (These links have probably updated since I posted them, so the story may have changed. Lots of buildings shaking farther away, Boston to South Carolina.
• Epicenter near the North Anna nuclear power plant, which shut down automatically. Backup generators switched on safely. (Remember it was the failure of backup generators that accelerated the Fukushima nuclear disaster.)
• Virginia Tech has an important seismological research site here.

2011 disaster frequency ties mark

Via the cat-bond loving Artemis and a few other sites: NOAA has updated its study of $1B+ disasters. (This is measured in 2011 economic losses, not insured losses, which are generally much less.)

The takeaway – 2011 has had nine billion-dollar babies. That ties the post-1980 record (2008), and there’s still 4½ months left, including the nastiest part of hurricane season. For the record:

• Upper Midwest Flooding, Summer – $2.0B
• Mississippi River flooding, Spring-Summer – $2.0B-$4.0B
• Southern Plains/Southwest Drought, Heatwave, & Wildfires, Spring-Summer – $5.0B (so far)
• Midwest/Southeast Tornadoes, May 22-27 – $7.0B
• Southeast/Ohio Valley/Midwest Tornadoes, April 25-30 – $9.0B
• Midwest/Southeast Tornadoes, April 14-16, 2011 – $2.0B
• Southeast/Midwest Tornadoes, April 8-11, 2011 – $2.2B
• Midwest/Southeast Tornadoes, April 4-5, 2011 $2.3B
• Groundhog Day Blizzard, Jan 29-Feb 3, 2011 $2.0B

NOAA has also put together some nifty graphics, perhaps the most striking of which is the map above, showing how the Southeast gets hit most frequently. Many of these graphics are doubtless on the way to a PowerPoint presentation near you.

Storm season starts spinning

As the stock market kind of, you know, melts, the Atlantic hurricane season appears to be heating up. Artemis channels Accuweather:

So far, a high over Bermuda and a high over the U.S. have formed – in football terms – a blocking wall that has suppressed potential hurricanes off Africa, steering them too far south or spinning them too far east. The easternmost one will move east next week (the 17th), and the westernmost one will move west. To carry on the football metaphor, that leaves a gap in protection over the Southeast U.S.

Meanwhile, the typical developments that make August nail-biting time are spinning out storms with their usual efficiency. Accuweather says three could emerge by Aug. 25. But there are pockets of wind shear that will likely inhibit the Cape Verde storms from turning outrageous for the next couple weeks.

 

FL HO market: Undercapitalized?

Snagging some confidential documents from the Department of Insurance, Sarasota Herald-Tribune reporter Paige St. John questions the financial strength of several leading Florida homeowners insurers, including the state’s largest private HO writer – Universal P&C – and the Florida arms of Allstate and State Farm.

(Let’s add quickly: Allstate Florida and State Farm Florida are subsidiaries of much larger organizations. So the supposed threat to the Florida companies doesn’t extend to the parents.)

The problem: According to the documents, those companies don’t have the capital to withstand a 100-year hurricane. More than a half-dozen smaller companies have the same problem.

How does this happen? Looser regulation, according to the report. Until 2010, the state required them to show their ability to withstand a 100-year storm. But according to St. John, they gamed the process. Insurance Commissioner Kevin McCarthy removed that requirement, hoping premiums would fall.

And some insurers appear to have gamed the system. They used a tough model to set cat loads for their rates, resulting in higher rates. But they turned to a milder model for the report the state requires.

Other companies ignored the impact of demand surge, the very real inflation in construction costs that follow a storm.

Insurers defend themselves:

Almost all of the companies disputed the state-required test and said they could survive based on their own methods that predicted substantially smaller hurricane losses.

If the big one hits, St. John’s report concludes, hundreds of thousands of policyholders could lose their insurers, and the remaining insurers and taxpayers would end up with the bill.

Of course, the reporter herself appears to have played both ends of the cat modeling game. She excoriated insurers for depending on them to set rates, implying rates are too high. Now she criticizes insurers for failing to rely on them enough, implying insurers’ capital is too low.

Rather than wonder what the reporter really believes, I’ll just say that all insurers have an important interest in the capital adequacy of every insurer.

The story is here, and details on how all the state’s insurers fare on the state’s scenario test are here.

Brokers’ halftime reports

In a sentence: The market has done just about everything necessary to turn, except turn.

A lot about market uncertainty in these reports, which always turns me off. What, after all, is certain? Beyond that, it’s clear that everyone believes a big blow will drive rates up. But there’s not a lot of confidence about what will happen if hurricane season is calm.

Details and links below.

Willis

Willis tells us that any turn in the market “is unlikely to follow historic patterns.” But in the face of 16 months with $86B in insured cat losses ($46B to reinsurers), the broker’s data indicate that for reinsurers a hard market is basically here:

• Cat rates higher by double digits.
• Per risk rates generally 5% to 10% higher.
• Casualty rates flat.
• Specialty (engineering, marine, accident, et al.) changes vary by line.
• U.S. workers comp rates stable.

Willis has some nifty charts showing rate levels over long periods, like this one for U.S. catastrophe rates:

Holborn

Reinsurers have had “three Katrinas” since 2009, constraining capital on the order of $60B (Japan and other cats dating back to the Chilean earthquake; model changes requiring more capital to protect against U.S. hurricane). Even so, rates appear flat at midyear in catastrophe, per risk, clash and casualty markets. Future rate changes will depend on how the U.S. wind season plays out.

Holborn notes that 2010 and 2011 large losses have hit reinsurers harder than the cat heavy years of 2004 and 2005 (though, I’d add, not as big as 2001):

Holborn reports generally get posted here, but this one doesn’t appear to be up yet. Here’s a copy.

Guy Carpenter

Carpenter spouts the uncertainty line.

• Moderate decline in capital slowing share repurchases.
• Firmer rates on line for property cat at 4/1, 6/1 and 7/1

Losses from recent events are not fully developed and there is not a consensus position on the integration of RMS v11.

GC’s most interesting stuff comes in the cat bond/ILW arena. Channeling GC’s report, Artemis points out that cat bond issuance has dried up in second quarter (after a record Q1). There’s plenty of capital to be had, but not much risk transferring out. And what remains is heavily driven by U.S. wind.

Haven’t seen anything from Aon yet. Probably out today.

Spectre of fraud haunts FL property market

Among the myriad problems the Florida homeowners market suffers: fraud-like behavior. (Via RiskMarketNews on twitter) Sayeth the Palm Beach Post:

The state requires insurers to issue discounts if a property is solidly built – credit for having hurricane shutters or specially installed straps to hold a roof in place. Only problem – most properties that get the credit don’t deserve it, based on inspections by Citizens Property, the state-run market leader:

Since the company started reinspecting with an eye toward catching deception, 65 percent of single-family homes have lost credits. Among commercial properties, 53 percent inspected were found to have discounts they didn’t deserve.

Other insurers are stepping up inspections. This isn’t too big a surprise – here’s a slide that Locke Burke, chairman and president of Security First, dropped at the CAS Spring Meeting last month:

The average reinspected home had been paying about $165 less than they should have. The average older home (pre-95) was underpaying by more than $300.

Hard to blame the property owners here, as they are only hiring inspectors, not submitting results. However there’s a contractor problem here. The Palm Beach Post notes:

Among the abuses noted by the state Office of Insurance Regulation were unqualified or unregulated inspectors, vague forms and a lack of documentation proving homeowners took the measures they said they had taken to harden their homes.

And it’s a shame. I support the credits. Construction makes a huge difference in being able to withstand a hurricane. I think every home in Florida should be retrofitted and inspected by a private-public consortium.

Tornado season: How bad?

I was hasty in proclaiming this year’s tornado season the worst ever, picking up a chart from NOAA that showed more tornadoes reported at this point than in any year prior.

Claire Wilkinson over at Terms + Conditions looks at the tornado stats in detail:

But before we jump to conclusions about record-breaking numbers, it’s important to read the fine print.

First, these figures from NOAA’s Storm Prediction Center are a preliminary count of eyewitness reports for tornado events not a count of actual tornadoes.

SPC also cautions that comparisons between preliminary counts and actual counts from prior years should be avoided.

An article by the Dallas Weather Examiner points out that if all the 871 tornado reports during April 2011 verify for separate tornadoes, then this would eclipse the current monthly record of 542 tornadoes from May 2003.

But it goes on to suggest that because many of these reports are duplicates, the verified tornado total for April 2011 will probably come in below 542. This would leave May 2003 with the highest tornado count for any month.

In my (lame) defense, I picked up the screen grab from Eqecat to emphasize the main story, which was Eqecat’s estimate that last week’s tornadoes caused $2B to $5B in losses. But I should have gone back to verify.

Sorry.

Eqecat: Tornado-season tab tops $2B already

$2B to $5B is Eqecat’s estimate.

So far, it’s the busiest tornado season ever, as this NOAA chart shows:

So far, so bad

It’s a bit tough to read, but the chart shows the cumulative number of tornadoes in a year. The black, incomplete line shows this year’s activity. The fact that it is higher at end-April than all the other lines means there have been more tornadoes in the U.S. this year (835 through April 28) than in any previous year at this juncture. (Previous record: 556.)

(Incidentally, the words inflation-adjusted in the chart title refer to NOAA’s adjustment for the fact that better reporting nowadays means more tornadoes are reported. NOAA in essence is making the chart an apples-to-apples comparison.)

In other news, Eqecat points out the rain those storms dumped is making its way to the nation’s rivers. The Ohio River and the Mississippi south of Cairo, Ill., are well above flood stage, with more to come.

And wildfires in Texas have probably created $100 million in insured losses.

Some clarity on cat bonds

Wherein I chide Felix Salmon, the fine Reuters financial blogger, for his views on the cat market.

Mind you, I agree with his conclusion – that the catastrophe bond market is likely to remain small compared to the catastrophe reinsurance market. I just disagree with his reasoning.

Salmon is playing off of a Business Week article that describes nicely what a catastrophe bond is:

An insurance company issues bonds to financial investors, such as hedge and pension funds, that are willing to place a bet on the probability of a disaster occurring at a particular location and during a specific time frame. During the life of the bond, the insurer pays investors a coupon interest rate. If nothing happens, the insurer returns the money when the bond matures. If the fates are cruel, cat bond investors kiss off all or part of the principal.

And this is newsy because defaulting cat bonds will fund well less than 5% of the estimated $30B or so in Japan earthquake/tsunami losses.

Salmon maintains that “catastrophe bonds are the capital-markets security of the future, and they always will be,” maintaining that:

1. “Insurers will always accept lower returns on their capital than the kind of ROI that hedge-fund cat-bond buyers are looking for.”
2. Bondholders want the default to be triggered by the objective scale of an event (a Category 4 hurricane passing over latitude X and longitude Y with a windspeed of Z) while reinsurers pay losses based on the damage a storm does, which is harder to control, as it’s subject to vicissitudes of building codes, contractor costs and judicial fiat. The chance that the objective scale would be triggered when the damages don’t occur – or vice versa – is basis risk, and the reinsurer who wants to lay cat risk off into the capital markets doesn’t want to be stuck with it. Nor do bondholders.

I agree that cat bonds won’t dominate the markets, and basis risk is a big reason.

But I don’t think the former point holds up well. The catastrophe reinsurance business can have very attractive returns; however, you have to accept variability in those returns. The purest example of catastrophe reinsurance is probably Renaissance Re, and it has an average ROE of 23% since its formation in 1993, according to this investor presentation (pdf), found here. That’s a bit better than the typical cat bond, which has returns around eight percentage points above Libor, according to this Business Insurance article.

And traditional cat reinsurance should have better returns, because cat bonds bear less risk. Few Japan bonds defaulted because most had triggers tied to earthquakes closer to Tokyo. And in general, cat bonds are structured so the probability of default is remote. From the Business Week article:

“It’s almost like hole-in-one insurance,” says Nelson Seo, co-founder of Fermat Capital Management in Westport, Conn., which oversees about $2 billion, including cat bonds. “It’s been very good returns, and most of the investors in this space have been very happy with it.”

Bond investors don’t like defaults, and a cat bond structured to default when, say, a Category 2 hurricane hit Florida wouldn’t find much market support.

That fact by itself means most catastrophe losses will remain in the (re)insurance industry. Beyond that, I’m told, cat bonds are more difficult to structure than traditional reinsurance treaties, particularly if the bonds are subject to regulatory scrutiny.

A reinsurance treaty, by contrast, is a contract among a half-dozen parties, perhaps fewer. As the reinsurance world is small, the parties know each other well. The contracts are highly standardized, swapping in well-known clauses that vary in predictable ways. Processing the paperwork is relatively easy – so easy that it’s easy to forget to do it. The industry has needed policing to ensure that the contracts get signed promptly.

Besides, quite a few hedge-fund managers like the returns on cat reinsurance, even at lower layers. They embrace the variability since it is lightly correlated with overall market returns.

They can invest directly in a company or fund a sidecar – a short-term reinsurance company that takes a portion of the catastrophe business that a larger reinsurer writes. Alterra recently created one with Stone Point Capital, a private equity firm, in the wake of the Japan earthquake.

The bonds do have their place – they let reinsurers lay off their accumulated risk in extreme events, like a Tokyo earthquake. And like Salmon, I don’t think they will ever replace reinsurance. However I think the reasons have a lot to do with probability of default and less with the promised returns.