July 20th, 2009

Enhance Capital Productivity When a Hurricane Is Coming

Posted at 1:00 AM ET

harnick_michelle_photoMichelle Harnick, Managing Director

September 2008 brought two major shocks to the global (re)insurance industry. The financial catastrophe captured the headlines, ultimately depleting reinsurer capital by 18 percent, as measured by the Guy Carpenter Global Reinsurance Composite. At the same time, Hurricane Ike pushed through the Gulf of Mexico eventually costing carriers USD11.5 billion. These two events have left the industry in a capital-constrained environment. While last year’s surplus provided a sufficient cushion for absorbing the blows, the days of abundant capital are gone for the foreseeable future.

For the 2009 Atlantic hurricane season — and likely next year’s, as well — (re)insurers will need to do more with less. Earnings and return on equity (ROE) targets remain, and risk-bearers have smaller capital bases from which to take aim. To succeed — with the results measured in market capitalization — carriers need to make the capital they have as productive as possible, maximizing upside relative to stated risk appetites, profiles, and tolerances. Of course, this is a daunting prospect when a named storm is headed for a high accumulation of property risks.

Planning ahead, doubtless, is crucial to effective risk and capital management. But, with hurricane season upon us, foresight has been applied already. Near-term tools, on the other hand, can help (re)insurers fine-tune their portfolios when faced with a forming (or formed) tropical storm. GC LiveCat, developed by Guy Carpenter in partnership with WSI Corporation, provides 10-day forecasts and, once a storm has arisen, updates every 12 hours to support carriers in taking informed action — and in extending the value of capital deployed to reinsurance risks.

Thinner Balance Sheets

The (re)insurance industry entered 2008 with what many believed to be “excess” capital. Discussions revolved around how to put that cash to work to generate returns, given a shortage of opportunity relative to resources available. Nine months later, capital productivity concerns began to take a different form: carriers faced the prospect of having to do more with less, as financial and property catastrophes drained balance sheets severely. The dust didn’t settle until March 2009, when capital depletion was identified to have reached 18 percent, as measured by the Guy Carpenter Global Reinsurance Composite.


While Hurricane Ike caused USD11.5 billion in insured losses, its immediate predecessor, Hurricane Gustav, was much less severe. It only led to insured losses of approximately USD4 billion. As Gustav moved through the Gulf of Mexico, however, many (re)insurers noted its early trajectory and feared that Miami, Florida was in the storm’s sights. One “wrong” turn could have triggered profound economic and insured losses, compounding the problems of September 2008 exponentially.

It’s difficult to look back on last year and find a stroke of luck, but Hurricane Gustav’s close call with Miami suggests that the potential for loss last year was much higher than (re)insurers actually realized. An Atlantic hurricane season expected to be slightly above average in terms of the number of storms to form did not account for severity or where landfall would be made. A reprise in 2009, with carrier capital at much lower levels, would be even worse.

Fortunately, (re)insurers are not powerless in regards to their balance sheets, even with the availability of fresh capital limited. Disciplined risk management can reduce losses even when a hurricane is poised to strike. Livecat cover purchases have long been used to prevent near-term losses, but they have been limited by access to timely, accurate, and targeted information. GC LiveCat, which provides frequent updates from storm formation to dissipation, increases the value of livecat-based risk-transfer, making deployed capital more productive, even as an event is about to occur.

GC LiveCat: A Real-Time Solution

Developed in coordination with WSI Corporation, GC LiveCat supplements WSI’s livecat forecast with probabilities of landfall by gate and conditional exceedance probability curves which are updated every twelve hours. WSI’s LiveCat forecast also offers uncertainty estimates. Predicated upon state-of-the-art meteorological models to predict the track and intensity of hurricanes, these unique forecasts contain features previously unavailable to the marketplace, including hurricane predictions up to 10 days prior to landfall — several days earlier than what is currently provided by the National Hurricane Center (NHC) and other tropical forecasting organizations.

Four regional hurricane indices are at the heart of GC LiveCat: Northeast, Southeast, Florida, and Gulf. Guy Carpenter created these indices in response to the (re)insurance industry’s questioning the credibility of the catastrophe models after the 2004 and 2005 hurricane seasons — and (re)insurers’ requirement to better understand and manage their catastrophe risks.

Unlike most indices which do not differentiate by geographic location (and only take into account frequency or severity and historical climatologic information), the Guy Carpenter Hurricane Index not only addresses all the aforementioned information, but also takes into account current meteorological information and forecasts about live events, the forecast landfall location, and the forecast landfall probability and the conditional severity.

The creation of regional indices allows risk-bearers to use targeted insights to gauge and transfer property-catastrophe risk. Forecasts reflect a 10-day time horizon — double what was available previously — enabling carriers to plan farther ahead than ever before. Further, the index values are updated every 12 hours as a storm develops and moves. As a forecast is refined, (re)insurers can fine-tune their assumptions and actions, identifying key risks and securing the appropriate cover.

The GC LiveCat and GC ForeCat indices provide a comprehensive view of a real and imminent threat to carrier capital that provides a foundation for decision-making that minimizes a (re)insurer’s losses at a time when others may simply brace themselves for balance sheet damage. Ultimately, the point of using GC LiveCat is to take action — to transfer risk accurately and quickly.

Pair Insightand Action for Returns

This year, (re)insurers have had to extract as much value as possible from every dollar deployed. Mistakes are measured not just in losses but in missed opportunities, with the effects magnified by the loss of last year’s “excess capital” cushion. Any tool that can create more value per dollar applied to a particular risk will have an impact everywhere from the individual portfolio to the company’s share price.

GC LiveCat is a capital productivity multiplier. Securing livecat cover when a storm is approaching the coast is only as effective as the underlying information used to make the decision. With 10-day forecasts and updates every 12 hours, GC LiveCat makes these urgent capital management decisions more powerful, amplifying the effects of prudent risk-transfer. In a capital-constrained environment, this is an advantage that cannot be ignored.

Download the GC LiveCat fact sheet >>

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