Following the enactment of significant property insurance legislative reform in Florida and after giving these reforms time to bed-in, catastrophe bonds covering risks in the state are likely to become even more attractive to invest in, according to Dirk Schmelzer of Plenum Investments.
Florida’s lawmakers passed a raft of legislative reform in December, all of which was aimed at improving the property insurance market, reducing litigation and ultimately encouraging capital, including reinsurance, back to the state.
As we explained at the time, the reforms are a meaningful step in the right direction, but no panacea for all of Florida’s future insurance challenges and it will take time for their effects to become apparent.
But they will remove certain legal and fraud related risks, that have been driving significant loss amplification and loss creep to reinsurance and insurance-linked securities (ILS) markets, while ultimately also creating a more robust framework for property insurers to operate in, all of which should be very positive.
Commenting on the reforms in a recent paper, Dirk Schmelzer, Managing Partner, Senior Portfolio Manager at catastrophe bond focused investment manager Plenum Investments, explained that the passage of these reforms will benefit the catastrophe bond market and its investors.
He expects the improved risk environment, in Florida’s property insurance and reinsurance market, thanks to the reforms, will result in a more dynamic and diverse opportunity for catastrophe bond investors targeting the state, making issuances covering Florida risks even more attractive.
The removal of a significant proportion of the litigation that has plagued Florida’s insurance claims environment for years, is a significant driver in Plenum’s view, along with issues such as one-way attorney fees and assignment of benefits (AOB), both of which should be dramatically reduced by the recent reforms.
Importantly though, Schmelzer notes that reduced insurance premiums for Florida’s home and business owners could be some way off, even with the reforms, as risk commensurate pricing is required.
But, if the reforms are successful at attracting new investment and reinsurance capital back to Florida, then in time at least the market has a chance to be more accurately priced, even if this does not equate to much lower-priced (if at all).
“In the reinsurance industry and the Insurance-Linked Securities ILS market, the consequences of the recent legislative reform will lead to a reassessment of Florida risks,” Schmelzer of Plenum Investments believes.
Hurricane risk from Florida is already perhaps the most dominant peak peril in reinsurance and the ILS market, and in recent years the pricing has become more attractive too, a degree of which has been down to the uncertainty in loss development in the state.
Schmelzer explains the current lie of the land in Florida, with the reforms enacted but yet to be proven as effective.
“Reinsurers and ILS investors are still cautious about taking on more Florida risks, not least because risk premiums have also risen significantly outside Florida. In the medium term and subject to further major loss events, capital inflows and thus increasing competition can also be expected again on the reinsurance side.
“As in the primary insurance sector, this development is not expected to begin immediately. Reinsurers and ILS investors need to ensure that the legislative adjustment adopted is effective and that the premium level achieved is sufficient to cover claims costs – also in view of the consequences of climate change – capital costs, expenses and an adequate profit margin before expanding exposure in Florida,” he explained.
Schmelzer goes on to explain that the issues in Florida have been well understood in the insurance-linked securities (ILS) market for some time, resulting in steps being taken to mitigate the volatility inherent in Florida loss events.
“So CAT Bond investors, especially after the experiences following Hurricane Irma, have been pushing for the loss adjustment expenses (LAE), which go beyond the actual property damage, to be settled only via a fixed factor. The risk of an adverse development of this cost block then remains with the ceding company of the CAT Bond, i.e. the insurer,” Schmelzer explained.
He also noted that cascading, or top-and-drop structures, that had been more prevalent within cat bonds sponsored by Florida domestic insurers in recent years, have now all but disappeared from the cat bond market.
Schmelzer said that, “The shortage of reinsurance capacity in recent years, which was further accelerated by Hurricane Ian, has given ILS investors greater bargaining power to enforce these changes”
The reforms can give greater claims certainty to insurers, which can help to make cat bonds a more attractive reinsurance alternative again, also increasing the certainty on the investor side as well.
“A revival of the private insurance market in Florida should also result in insurers seeking a path to the CAT Bond market, which should open up better selection and diversification opportunities for ILS investors,” Schmelzer believes.
Summing up, Schmelzer said that, “As CAT Bond investors with a long-term perspective on this market, we welcome these reforms.”
As, “The legis- lative reform reduces the amount and uncertainty of claims settlement costs for future insured events in Florida.”
Plenum Investments believes the litigation costs related to claims settlement could be lowered by at least 50% as a result of the enacted reform legislation.
That’s significant, especially when you consider how a hurricane like Irma might have developed differently for the ILS market had these reforms been in place, as well as the tighter terms seen in the catastrophe bond market today.
“This also affects the ratio of reinsurance premium income to expected claims payments and leads to an improved adequacy of the premiums charged, with a positive effect on the risk-adjusted compensation for CAT Bonds,” Schmelzer continued.
Adding that the duration of claims settlements after major catastrophes should also be reduced, so loss development could be shorter as well, with positive ramifications for trapping of ILS collateral and extensions of maturity for catastrophe bonds.
This can help to “provide CAT Bond investors with quicker clarity about the expected payouts,” Schmelzer said.
Adding that, “The existing uncertainty in the modelling will also be reduced if unilateral legal fees and assignment of benefits make a smaller contribution to the claim amount, as these are not included in the models.”
Even with the risks reduced by these laws, Plenum does not feel premiums will drop in Florida though, which it sees as “mainly due to the high claims burden from past events such as hurricanes “Ida” and “Ian”, rather than the litigation cost component of claims settlement.”
“However, we expect the bill to make the Florida CAT Bond market more dynamic and diverse as new insurers enter the more attractive Florida market. This will provide CAT Bond investors with a broader and more diverse choice of investments in the future,” Schmelzer explained.
Summing up that, “Even before the legislative reform, the CAT Bonds market was very promising, with premium levels at a 20-year high. Combined with the improvements as a result of the law reform, this market will become even more attractive in the future.”