Insurers Using More CAT Bonds
Insurers of the last resort are increasingly using catastrophe bonds and other similar products to transfer some of their peak exposures to the capital markets, according to a rating agency A.M. Best.
Insurers of the last resort are those that include Fair Access to Insurance Requirements (FAIR) plans, quasi-state-run insurance companies and beach/windstorm plans.
According to a report by A.M. Best, these entities have welcomed the growing availability of insurance-linked instruments such as catastrophe (CAT) bonds, insurance-linked funds and industry loss warranties (ILWs).
“Given an increase in exposure to loss for insurers of the last resort, CAT bonds have provided another alternative for these entities to cede part of their peak exposures as a complement to the traditional reinsurance market,” said Asha Attoh-Okine, author of the report.
“Catastrophe bonds also provide multi-year coverage as opposed to most traditional reinsurance programs,” he said.
Approximately $5.6 billion in CAT bonds have been issued by seven of these entities from 2009 through Sept. 30, 2014, according to the A.M. Best report.
The two main perils that were covered were hurricanes and earthquakes occurring in the respective regions that the bonds were placed.
Hurricanes accounted for approximately $4.53 billion, or 81 percent, with earthquakes taking the other $1.05 billion, or 19 percent, for these entities during the period reviewed by the ratings agency.
“The increased use of these insurance-linked instruments is due to growth in investor demand,” said Attoh-Okine.
“We have specialized insurance-linked securities funds, whose mandate is to invest in insurance exposure, hedge funds, and pension funds all participating in this market. Investors have been attracted to these products given the low-interest environment for fixed income securities of similar quality and the perceived minimal correlation to the general financial market.
“Sponsors have also continued to increase the use of CAT bonds and other insurance-linked instruments to cede their peak exposures.
“Lately,” he said, “we have seen a decrease in spread [price] for the same level of risk for CAT bonds, providing sponsors cost relief when compared to the traditional property catastrophe reinsurance market.”
Advantages and Drawbacks
Among the advantages such products offered insurers are multi-year coverage and minimal credit risk versus the traditional reinsurance market, he said. They also provide another dimension to diversify and manage catastrophe risk.
“The main drawback for some of these instruments, for example, CAT bonds and ILWs, is the lack of reinstate features when compared to the traditional reinsurance program. (Reinstate implies the restoration of the reinsurance limit of an excess property treaty to its full amount after payment by the reinsurer of a loss as a result of an occurrence).
“Another criticism for the use of these instruments,” he said, “is whether investors’ participation will continue in case of property catastrophe insurance market disruption as result of a huge catastrophe event or if we start seeing a continuous increase in returns for other fixed income instruments.”
According to Attoh-Okine, if a major hurricane or other natural disaster triggers one of the CAT bonds, the sponsor of the bond will be reimbursed for the loss amount up to the amount of the CAT bond. In such a case, investors will lose part or all of the principal amount and the corresponding interest proceeds.
The A.M. Best report concluded that the increasing usage of CAT bonds and similar instruments add to recent improvements in the modeling of peak risk exposures, but also “adds another dimension to diversifying and managing catastrophe risk.”
In addition, the report said, other areas that might benefit from the use of various capital market instruments to transfer insurance risk include terrorism risk exposure; assigned risk non-property plans facing inadequate pricing/capacity issues, (e.g., workers’ compensation, auto, accident/health, etc.; and the National Flood Insurance Program, which provides flood insurance to approximately 5.5 million U.S. properties with total insured values exceeding $1 trillion, and growing.
Congress Must Act in 2015
I am disappointed by Congress’ decision to adjourn last week without taking action on legislation to reauthorize of the Terrorism Risk Insurance Act (TRIA) and enact the National Association of Registered Agents and Brokers (NARAB) — and I speak for the entire NAPSLO organization and membership.
As a result of that inaction, insurers and insureds are astounded and scrambling to address the increased exposure of the expiring federal backstop.
Carriers, brokers and insureds are now faced with potential terrorism exclusions and/or acceptance of the exposure between Dec. 31 and the time by which Congress takes needed action — exposure that was assessed and priced assuming Congress would reauthorize TRIA before adjourning in 2014.
NAPSLO believes TRIA has been an important tool for insurers to better manage the risk of terrorism events and provides certainty to the industry in offering private capital and solutions to policyholders.
Surplus lines insurers provided certain terrorism coverage pursuant to the mandatory provisions and subject to the deductibles and triggers of the existing federal program.
In general, we believe private market solutions should be exhausted before government-sponsored programs or residual markets are considered, and governments should not provide coverage options the private or open market is able to address.
However, we also believe a role exists for the federal government in the management of terrorism risk. Insurers can model the severity of a hypothetical terrorist attack, but it is impossible to model the likelihood or frequency of those attacks.
As a result, we have long supported a thoughtful and thorough review of TRIA with a goal of maintaining or increasing opportunities for capacity and solutions delivered by the private market.
NAPSLO has also strongly supported the enactment of NARAB. This critical legislation will streamline agent and broker licensing for those operating on a multi-state basis.
It would create a nonprofit board to be governed by state insurance regulators and industry representatives to create rigorous standards and ethical requirements with a goal of applying licensing, continuing education and nonresident insurance producer standards on a multi-state basis.
We were very pleased when the House of Representatives passed TRIA legislation on Dec. 10 that appeared to be a middle-ground compromise between the House and Senate proposals that had passed through their respective committees last June. That legislation would have extended TRIA for six years and enacted NARAB.
Unfortunately, when the TRIA and NARAB legislation moved to the Senate, leaders were unable to overcome the objections of one Senator in order to pass the bill. When a Member refused to support NARAB absent provisions allowing for states to opt-out of participation in the national licensing system, it marked the end of compromise for this year, and the end of TRIA until further action is taken.
This was a disappointing outcome for our industry and our nation’s insureds.
We at NAPSLO urge Congress to act on this issue as soon as members return on Jan. 6, 2015, as we believe this is an important issue for our nation’s economic security. We look forward to working with our industry partners and the new Congress to see legislation passed that will reauthorize TRIA and enact NARAB in early 2015.
From Coast to Coast
The 3,920-ton Left Coast Lifter, originally built by Fluor Construction to help build the new Bay Bridge in San Francisco, will be integral in rebuilding the Tappan Zee Bridge by 2018.
The Lifter and the Statue of Liberty
When he got the news, Scot Burford could see it as clearly as if somebody handed him an 8 by 11 color photograph.
On January 30, the Left Coast Lifter, a massive crane originally built by Fluor Construction to help build the new Bay Bridge in San Francisco, steamed past the Statue of Liberty. Excited observers, who saw the crane entering New York Harbor, dubbed it the “The Hudson River Hoister,” honoring its new role in rebuilding the Tappan Zee Bridge over the Hudson River.
Powered by two stout-hearted tug boats, the Lauren Foss and the Iver Foss, it took more than five weeks for the huge crane to complete the 6,000 mile ocean journey from San Francisco to New York via the Panama Canal.
Scot took a deep breath and reflected on all the work needed to plan every aspect of the crane’s complicated journey.
A risk engineer at Liberty International Underwriters (LIU), Burford worked with a specialized team of marine insurance and risk management professionals which included John Phillips, LIU’s Hull Product Line Leader, Sean Dollahon, an LIU Marine underwriter, and Rick Falcinelli, LIU’s Marine Risk Engineering Manager, to complete a detailed analysis of the crane’s proposed route. Based on a multitude of factors, the LIU team confirmed the safety of the route, produced clear guidelines for the tug captains that included weather restrictions, predetermined ports of refuge in the case of bad weather as well as specifying the ballast conditions and rigging of tow gear on the tugs.
Of equal importance, the deep expertise and extensive experience of the LIU team ensured that the most knowledgeable local surveyors and tugboat captains with the best safety records were selected for the project. After all, the most careful of plans will only be as effective as the people who execute them.
The tremendous size of the Left Coast Lifter presented some unique challenges in preparing for its voyage.
The original intention was to dry tow the crane by loading and securing it on a semi-submersible vessel. However, the lack of an American-flagged vessel that could accommodate the Left Coast Lifter created many logistical complexities and it was decided that the crane would be towed on its own barge.
At first, the LIU team was concerned since the barge was not intended for ocean travel and therefore lacked towing skegs and other structural components typically found on oceangoing barges.
But a detailed review of the plan with the client and contractors gave the LIU team confidence. In this instance, the sheer weight and size of the crane provided sufficient stability, and with the addition of a second tug on the barge’s stern, the LIU team, with its knowledge of barges and tugs, was confident the configuration was seaworthy and the barge would travel in a straight line. The team approved the plan and the crane began its successful voyage.
As impressive as the crane and its voyage were, it was just one piece in hundreds that needed to be underwritten and put in place for the Tappan Zee Bridge project to come off.
The rebuilding of the Tappan Zee Bridge, due to be completed in 2018, is the largest bridge construction project in the modern history of New York. The bridge is 3.1 miles long and will cost more than $3 billion to construct. The twin-span, cable-stayed bridge will be anchored to four mid-river towers.
When veteran contractors American Bridge, Fluor Corp., Granite Construction Northeast and Traylor Bros. formed a joint venture and won the contract to rebuild the Tappan Zee, one of the first things the consortium needed to do was find an insurance partner with the right coverages and technical expertise.
The Marsh broker, Ali Rizvi, Senior Vice President, working with the consortium, was well known to the LIU underwriting and engineering teams. In addition, Burford and the broker had worked on many projects in the past and had a strong relationship. These existing relationships were vital in facilitating efficient communication and data gathering, particularly given the scope and complexity of a project like the Tappan Zee.
And the scope of the project was indeed immense – more than 200 vessels, coming from all over the United States, would be moving construction equipment up the Hudson River.
An integrated team of LIU underwriters and risk engineers (including Burford, Phillips, Dollahon and Falcinelli) got to work evaluating the risk and the proper controls that the project required. Given the global scope of the project, the team’s ability to tap into their tight-knit global network of fellow LIU marine underwriters and engineers with deep industry relationships and expertise was invaluable.
In addition to the large number of vessels, the underwriting process was further complicated by many aspects of the project still being finalized.
“Because the consortium had just won this account, they were still working on contracts and contractors to finalize the deal and were unsure as to where most of the equipment and materials would be coming from,” Burford said.
Despite the massive size of the project and large number of stakeholders, LIU quickly turned around a quote involving three lines of marine coverage, Marine Liability, Project Cargo and Marine Hull & Machinery.
How could LIU produce such a complicated quote in a short period of time? It comes down to integrating risk engineers into the underwriting process, possessing deep industry experience on a global scale and having strong relationships that facilitate communication and trust.
Photo Credit: New York State Thruway Authority
When completed in 2018, the Tappan Zee will be eight lanes, with four emergency pullover lanes. Commuters sailing across it in their sedans and SUVs might appreciate the view of the Hudson, but they might never grasp the complexity of insuring three marine lines, covering the movements of hundreds of marine vessels carrying very expensive cargo.
Not to mention ferrying a 3,920-ton crane from coast to coast without a hitch.
But that’s what insurance does, in its quiet profundity.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.