Florida demand shifts to ILS sweet spot

Demand for Florida reinsurance cover is likely to be subdued at 1 June, as experts said that increased use of state reinsurance is expected to have a bigger impact on the market than stricter ratings agency requirements.

A move to roll back changes to second-event reinsurance requirements has thwarted hopes of more significant new demand, but appetite for private market cover is likely to shift to more remote risk levels which may suit ILS players.

This came after a group of nine Florida insurers, including UPC Insurance, Florida Peninsula and Heritage, lifted their participation in the state-backed Florida Hurricane Catastrophe Fund (FHCF) to the highest possible level.

These demand changes come as Florida insurers seek to manage their reinsurance costs amid pressure from reinsurers to increase rates.

Kapil Bhatia at consultancy firm Raymond James estimated that the average participation rate in the FHCF this year would move to approximately 81 percent – on par with 2015 levels – indicating that around $2bn of limit could be repositioned in the market.

When FHCF take-up levels rise, insurers obtain more lower-lying cover from the state and shift their private reinsurance buying to layers that wrap alongside or above the FHCF.

Another source projected that a move to the private market at top layers and FHCF wrapper layers would shift demand to “the sweet spot where alternative capacity and ILS likes to play”.

However, demand being at the high end of reinsurance towers will temper total volumes of premium increases expected this year, another expert suggested.

In 2018-2019, there was an average participation rate of 73.1 percent and an industry co-participation alongside the FHCF of $6bn. The prior year, when take-up rates were a little higher at 74.8 percent, the co-participation was $5.4bn.

Meanwhile, ratings agency Demotech told insurers at the start of March that it had moved its minimum expectation on reinsurance cover from a 1-in-100-year first event to 1-in-130 years.

But market sources said many carriers were already buying close to these levels.

This point was backed up by Demotech’s president Joe Petrelli. He told Trading Risk that 35 out of the 52 Floridian insurers it rates already bought at least enough reinsurance for a 1-in-130-year first event.

“It is good for consumers to know these companies are buying a very serious amount of vertical limit,” he argued.

When the original notice changing the guidelines came out, Demotech was also planning on moving the second event coverage requirement from 1-in-50 years to 1-in-70 years.

One underwriting source said this could have had a more significant impact on boosting demand than at the first-event level.

But as Petrelli admitted, the agency reversed this suggestion “very quickly”. He highlighted that the “overwhelming majority of companies” had purchased second-event cover well in excess of 1-in-50 in their 2018 programmes.

“We did roll back to 1-in-50 because the odds in one particular season of having a 1-in-130 and a 1-in-70 [storm] were so remote,” said Petrelli.

Adding: “From our perspective, the additional value of the 1-in-70 [cover] was not worth the disruption in 2019.”

Another source pointed out that if Florida insurers bought more cascading severity cover, this would provide them with better sideways coverage for multiple events as the limit can shift down to a lower trigger if underlying cover has been used up. 

Petrelli also noted that most companies buy these cascading “top and drop” layers, as he described the new guidance as “very rigorous”.

State coverage

The FHCF provides $17bn of reinsurance coverage, irrespective of insurer participation rates. When insurers elect less on average the FHCF reinsurance layer becomes “long and thin”, extending higher into most towers and exhausting at more remote return periods, according to Milliman actuary John Rollins. This was seen in take-up patterns in 2015-2017.

“When insurers gravitate to 90 percent, as they did from 2005-2014, the layer becomes short and fat”, Rollins continued, noting that in effect the resources in the cat fund moved to cover the more expensive lower layers of the market.

The FHCF revealed in March that nine companies had upped their participation to 90 percent, one moved from 45 percent to 75 percent and two dropped from 90 percent to 75 percent.