September 20th, 2010

World Catastrophe Reinsurance Market: Part I, Introduction, Catastrophe Events

Posted at 1:00 AM ET

Executive Summary

2010 has been a difficult year for the reinsurance industry after it suffered one of the most costly first halves on record. Spiraling costs from disasters such as the Chilean earthquake and the Deepwater Horizon explosion in the Gulf of Mexico meant (re)insurers’ catastrophe budgets took a severe hit even before the hurricane season had started. Although insured losses reached USD23 billion in the first six months and an active hurricane season has been forecast, reinsurance rates generally declined through the 2010 renewals as surplus capital drove down prices.

According to the Guy Carpenter World Rate on Line (ROL) Index, global catastrophe reinsurance rates fell by 6 percent on average through the 2010 renewal season. Although markets that suffered catastrophe losses in early 2010, such as Chile, saw prices increase, the underlying trend elsewhere was one of rate reductions. One of the main reasons for falling rates is excess capital in the reinsurance market. Guy Carpenter estimated that the sector was overcapitalized by as much as USD20 billion,or 12 percent, at the beginning of 2010. Although the overcapitalization fell back to around 8 percent by the end of June, the surplus capital among reinsurers remained the driving factor at the 2010 renewals.

As ever, it only takes one market-changing event to precipitate a turn in the market. One of the dangers of writing an update on the reinsurance market at this time of year is the situation can change in an instant, especially when an active hurricane season has been predicted. It is clear that market conditions through the rest of this year will be influenced by the extent reinsurer capital is eroded by loss activity.

Indeed, the marketplace will look very different at next year’s January 1 renewal if a big loss were to occur in the second half of 2010. A loss in the region of USD20 billion to USD30 billion, while not likely to lead to significant rate hardening, would decrease capacity and stabilize the market. Multiple losses in this range would likely bring about significant change as retention levels would be hit while a loss exceeding USD50 billion could see an immediate correction in pricing. However, if no market-changing event were to occur excess capital is likely to continue to depress pricing.

The outlook for the catastrophe bond market will also be influenced by catastrophe activity in the second half of 2010, and the Atlantic hurricane season particularly. Eight catastrophe bond transactions were completed in the second quarter of 2010, with USD2.05 billion in risk capital coming into the market, making it the second most active second quarter on record. Of this total, USD1.7 billion included exposure to US wind.

The reinsurance market faces many challenges as it starts to focus on January 1 renewals for 2011. Weak pricing, combined with forthcoming regulatory change that includes Solvency II and tax legislation in the United States, provides a difficult operating environment for (re)insurers in the near-term. Guy Carpenter remains committed to understanding our clients’ reinsurance needs and offering superior advice. By developing solutions such as i-aXs® and our new probabilistic flood model for France, Guy Carpenter continues to respond to the requests of clients to assist them in making better informed risk management and reinsurance decisions.

Catastrophe Events of 2010

The first six months of 2010 saw significant losses from global catastrophes. The 8.8Mw earthquake in Chile, combined with the Deepwater Horizon disaster in the Gulf of Mexico and hefty storm losses in the United States, Europe and Australia, meant (re)insurers experienced one of the most costly first halves on record. Guy Carpenter figures show insured losses in the first six months of 2010 reached USD23 billion. This figure is double the first half loss average recorded since 2000 and it even surpasses the figure for 2008, when the previous record for first half losses was set (1).

Significant Insured Losses of 2010

The record first half losses were due mainly to events that occurred in the first three months of 2010, including the Chile earthquake in February, Windstorm Xynthia and severe weather and flooding events in the United States and Australia (see Table 1). The Deepwater Horizon explosion in the Gulf of Mexico in the second quarter, along with more storms and flooding in the United States and Europe, added to the total and brought insured losses in the first half of 2010 close to the total for 2009 as a whole (1).


The first major catastrophe of 2010 occurred in Haiti when a 7.0Mw earthquake struck around 25 kilometers (15 miles) southeast of the country’s capital, Port-au-Prince. The arthquake devastated Haiti, killing more than 220,000 people and causing an economic loss of around USD8 billion. Due to the extremely low insurance penetration in the country, only USD150 million of this amount was insured1. However, the event did trigger Haiti’s earthquake coverage with the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which paid out USD7.75 million to the Haitian government, the full policy limit. All sixteen members of the CCRIF have subsequently renewed their earthquake and hurricane policies for 2010/11 (2).

The costliest weather-related event during the first half of 2010 came when Windstorm Xynthia hit parts of Spain, France and central Europe in late February. Xynthia’s wind gusts reached 200 kmph (130 mph) over the summits of the Pyrenees and around 160 kmph (100 mph) along coastal regions, causing damage to residential and commercial properties as the storm moved across Europe. Overall losses amounted to USD4.5 billion and insured losses reached USD3.4 billion (3).

Chile Earthquake

However, it was the Chile earthquake in February that left the (re)insurance industry with the heaviest loss in the first half of the year. The earthquake, measuring 8.8Mw and located around 100 kilometers (60 miles) northeast of Concepción City, was the joint fifth largest earthquake ever to be recorded. Officials in Chile said about 1.5 million homes were damaged, a third of them severely, and hundreds of thousands of people were left homeless. Several copper mining operations and oil refineries in the area sustained some damage while the country’s pulp, fishing and wine industries were also badly affected.

Following early insured loss estimates of around USD2 billion, the Chilean earthquake looks increasingly likely to be a bigger market loss than originally expected. Loss estimates have been revised upwards in the weeks and months since the earthquake, and there now seems to be growing consensus that the loss will total between USD6 billion to USD12 billion. Munich Re recently said the earthquake’s cost to the industry is likely to be USD8 billion due to the high insurance penetration levels in Chile’s commercial and industrial sectors. The Chilean insurance association, AACH, said 90 percent of the loss is expected to be paid by reinsurers.

If confirmed, this would make the event the second most expensive earthquake on record after the Northridge earthquake of 1994, and ahead of the Tokyo and Kobe events of 1923 and 1995 (see Table 2). It would also make the Chilean earthquake the most expensive insured event to hit Latin America and one of the biggest non-United States losses ever.


However, much uncertainty remains about the final insured loss for the Chile earthquake. Eight months after the 1994 Northridge earthquake in Southern California, the Insurance Services Office’s Property Claims Service (ISO PCS) was estimating insured losses to be around USD9 billion. However, some 17 months after the event, the PCS loss figure had increased to USD12.5 billion, a 40 percent increase. Historical events suggest earthquake losses take longer to develop when compared to typical wind losses (see Figure 1). This is in part due to business interruption losses mounting over a longer period of time, and the difficulty in calculating such costs means a similar increase could happen in Chile.


Deepwater Horizon Oil Spill

The sense of uncertainty felt by (re)insurers over the ultimate cost of catastrophe claims from early 2010 was compounded in April when the Deepwater Horizon drilling rig exploded in the Gulf of Mexico. Up to 62,000 barrels of oil per day were released into the Gulf after the rig sank on April 22, resulting in the biggest accidental oil leak ever (4). Despite several containment operations in the aftermath of the incident, they could not prevent the oil slick from reaching the Gulf coastline and causing disruption to local residents and businesses, particularly the fishing industry and tourism. The leak was temporarily capped in July and the well was scheduled to be permanently sealed in August after spilling 4.9 million barrels of oil into the Gulf of Mexico.

BP led the Deepwater Horizon project, with a 65 percent share in the well, while Anadarko Petroleum and Mitsui Oil Exploration owned 25 percent and 10 percent, respectively. To add to the complexity, other companies were involved in the project, including Transocean, Cameron and Halliburton. BP self insures its risks through its captive, Jupiter Insurance, rather than buying protection in the commercial market. The insurance coverage available to the other companies involved in the project is set out in Table 3, and it seems to support the estimated market loss range of USD1.5 billion to USD3.5 billion. The ultimate loss will depend on where responsibility is apportioned and how liability placements respond.

While BP has stressed it is responsible for the clean-up and pledged to pay legitimate compensation claims (5), the fact that it is self insured will help limit the cost to the private market. However, the allocation of payment is likely to be decided in the courts as long-running lawsuits are expected. BP has already said that Anadarko and Mitsui, as partners in the venture, should bear some of the costs but neither have agreed to reimburse BP yet.

It is still too early to know what the ultimate economic cost of the disaster will be, but the USD20 billion compensation fund set up by BP indicates the final figure will be substantial. The effect the incident will have on the reinsurance market is still unravelling, but the loss is potentially a market-changing event for energy and liability exposures given the potential length of the disaster’s tail. The incident is likely to be the second biggest energy insurance loss based on current estimates, behind the 1988 Piper Alpha oil platform explosion in the North Sea which caused an insured loss of around USD3.6 billion in 2009 dollars (6).

Early indications suggest the cost for insuring offshore oil rigs in the Gulf of Mexico could rise significantly in 2011. In addition, reinsurers are likely to demand greater transparency on future renewals and will require much more information regarding the direct market’s involvements in excess liability placements. Furthermore, a bill currently being debated in the US Senate that calls to increase the cap on liability payouts from USD75 million to USD10 billion for companies involved in offshore disasters, and possibly apply it retrospectively, could have huge implications on offshore liability policies if it is passed into law.

Remainder of 2010

It was against this backdrop that the (re)insurance industry faced the 2010 hurricane season. There was a general consensus among meteorologists that the 2010 season would see unusually high activity. Forecasters have warned the combination of an emerging La Niña event and record warm tropical sea surface temperatures in the Atlantic Ocean mean conditions are conducive for increased hurricane formation.

This seemed to be confirmed in June when Hurricane Alex moved across the Gulf of Mexico to make landfall just south of the Texas/Mexico border, causing an insured loss of around USD200 million. Alex was the first Atlantic hurricane to reach category 2 status in June since Hurricane Alma in 1966. Although storm activity through July was limited, forecasters are still predicting an unusually busy hurricane season as conditions are expected to become more favorable for storm development as we move into the period of peak activity.


1 Munich Re Press Release - July 7, 2010
2 The CCRIF said policy pricing was reduced as part of a planned strategy to minimize premium costs to its participating countries. As a result of increased
appreciation of seismic risk following the earthquake in Haiti, twelve member countries increased their coverage limit for earthquakes for 2010/11.
3 Munich Re Press Release - July 7, 2010.
4 Only the intentional release of an estimated 8 million barrels of oil into the Gulf by Iraqi troops during the Gulf War in 1991 was greater, according
to a US government report.
5 Under the Oil Pollution Act of 1990, offshore operators are liable for unlimited clean-up costs and up to USD75 million of liability costs.
6 Swiss Re: Natural catastrophes and man-made disasters in 2009.

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Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC.

MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance, or insurance product.

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