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Is This the Time to Consider Reinsurance for a Diversified Hedge Fund Portfolio?

Traders Magazine Online News, October 12, 2017

Donald Steinbrugge

Most institutional investors understand the uncorrelated, diversification benefits of property catastrophe reinsurance. Many have been waiting on the sidelines for a large event to happen that would drive up pricing before allocating to the strategy.  The two big questions these investors ask are, “Is pricing going up?” and “Has the probability of hurricanes increased?”

Will pricing on property catastrophe reinsurance increase?

 2017 has the potential to be the costliest year for the reinsurance industry on record, even worse than 2005 when the reinsurance industry was impacted by hurricane Katrina, Rita and Wilma.  Applied Insurance Research (AIR) Worldwide estimates that losses from Hurricane Maria could add between $40 billion and $85 billion to the insurance industry losses from recent catastrophes. When added to the devastation of Hurricane Harvey and Irma along with recent earthquakes in Mexico, losses could be as high as $165 billion based on AIR estimates of all events.

Insurance companies typically assume the initial losses from major events and purchase reinsurance to cover losses above a threshold. The most recent events will likely have a disproportionately large impact on reinsurance, compared to others in the insurance industry, as they trigger aggregate losses which exceed those thresholds

Prices for reinsurance are impacted by supply and demand. The potential $165 billion of lost capital will need to be replaced and will subsequently put upward pressure on pricing. In addition to the immediate material loss, a significant amount of capital will be locked up for accruals of potential claims at the end of 2017. This capital will be unavailable during the forthcoming January reinsurance renewal season. 

Fitch Ratings noted “Given the magnitude of the Maria-estimated losses, we now believe that 2017 catastrophe losses will constitute a capital event for a number of (re)insurance companies as opposed to just an earnings event.”  Companies faced with a potential downgrade will either have to raise capital or reduce their balance sheets, thereby putting further pressure on pricing. Price increases will be moderated by new capital coming into the industry but also enhanced by investors withdrawing capital from underperforming funds.

As a result property catastrophe reinsurance rates may increase to the highest level seen in years, especially in regions affected by the 2017 hurricanes and in the Retro (reinsurance of reinsurance companies) market. For example, before the most recent events, but after Hurricane Harvey and Irma, some reinsurance deals were completed with premiums 25% to 50% higher than deals earlier in the year.

Has the probability of future hurricanes increased?

There has been a lot of debate on the impact of global warming on weather patterns. However, there is no clear evidence supporting the theory that global warming is impacting property damage from hurricanes over the short term. The short term (one year or less) maturities of most reinsurance deals allow models to remain accurately applied in the face of gradually shifting weather patterns. As a matter of fact, over the previous decade and before the third quarter of 2017, the industry experienced below-average losses from hurricane-related catastrophes.

What is reinsurance?

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