Is the global reinsurance industry making Florida more resilient to climate change, hurricanes?

Third in a series. 

It’s no secret that Florida is one of the single most hurricane-prone strips of land in the world. This “land of sunshine, state of dreams,” as the celebrated Florida historian Gary Mormino dubbed Florida, seemingly attracts tourists, snowbirds and storms in equal measure. 

Indeed, seven of the 10 costliest hurricanes in U.S. history touched Florida, according to the Insurance Information Institute. To put that in dollars and cents, hurricanes have caused an average of about $2.3 billion dollars in damage every year over the last three decades, figuring for inflation. 

Florida’s unique exposure to risk is largely a function of the high concentration of development along the state’s 8,400 miles of coastline. In 2012, an estimated 79 percent of all of Florida’s insured property value, equal to roughly $2.9 trillion, was located in coastal counties, according to the global risk modeling firm AIR Worldwide. About 60 percent of that value is located in just 10 counties, largely in the South Florida and the Greater Tampa Bay metro areas.

In the short term, the amount of people and property at risk is only expected to grow as coastal property values continue to climb, construction continues and growing numbers of people choose to make Florida home. And over the longer term, rising sea levels and potentially stronger storms could amplify the number of communities at risk to some of the worst impacts of hurricanes, like storm surge. The Tampa Bay region is particularly vulnerable to impacts of the latter, in large part due to the shallow bathymetry of the Gulf of Mexico and the Bay.

Last year, the risk modeling firm Karen Clark & Company named the Tampa Bay region the single most at-risk area in the country for storm surge, estimating that a major hurricane could cause upwards of $175 billion in property damages. A number of efforts are underway across the region to adapt local solutions to the challenges posed by sea level rise.

Turning Florida wind risks into investment rewards

With great risk may come great reward. Some players in the global reinsurance industry are transforming these mounting natural catastrophe risks into a vibrant marketplace for new financial products and services. One such product is catastrophe bonds, or cat bonds for short, which are being pitched to property insurance companies as an alternative to reinsurance -- that’s insurance for insurers. 

Traditionally, reinsurance has been expensive to buy in “peak peril” markets like Florida, where catastrophe risks are highly concentrated. Cat bonds and other forms of insurance-linked securities (“ILS”) are transforming that market by bringing Wall Street investors into the reinsurance business, in what industry insiders call the “convergence” of insurance and the capital markets. 

Like traditional reinsurance, cat bonds allow insurers -- and sometimes reinsurers -- to cede, or transfer, a portion of their risk to a third party. In the case of the cat bond, that third party is a group of investors, typically in the form of pension funds, hedge
The risks associated with Florida hurricanes may be above average, but that also means that they’re potentially high yielding as financial products. And that risk is a generally well-known quantity to investors, who point to the availability of historic data and the growing sophistication of catastrophe risk models, which are used in the industry to gauge how different catastrophic scenarios could impact a given set of insured properties.
funds and other big institutional players. Should the ceding insurer realize a pre-agreed level of losses from a catastrophe, like potential wind damage caused by a major Florida hurricane, the third party becomes liable for paying out the bond. If the catastrophic event doesn’t happen, investors usually receive their principal back, plus interest. 

Cat bonds are not entirely new. The U.S. market for them dates back to Hurricane Andrew, which devastated South Florida in 1992 along with Florida’s property insurance companies. The $25 billion storm, which took 44 lives and left upwards of 175,000 homeless in Florida, caused 11 property insurers to fold up their Florida shops. That prompted the Florida Legislature to create the Florida Hurricane Catastrophe Fund and the predecessor of what is today Citizens, the state-owned property “insurer of last resort.” 

Although the first U.S. cat bond was issued in 1997, they didn’t attract serious investor interest until after Hurricane Katrina. Between 2007 and 2013 alone, investor participation in the cat bond market jumped from half a billion dollars to some $22 billion, according to the global reinsurer Hannover Re. 

Today, it’s hard to pinpoint the exact size of the broader global insurance-linked securities market, largely because the 50-or-so firms that create these deals are not legally required to disclose transaction details with the public. Nevertheless, multiple industry estimates peg the global ILS market at about $60 billion, with a little less than half of that taking the form of cat bonds.

The ILS market represents about 15 percent of the current global reinsurance business, and that share is on the rise. By the close of 2015, policies insuring Florida hurricane risk underpinned at least a third of all ILS deals, making it the single biggest source of risk in the global market, according to the 2015 ILS Annual Report released by Aon Benfield Securities. For now, that market doesn’t include Florida flood risks, the vast majority of which are insured through the National Flood Insurance Program (NFIP). Notably, however, there are several conversations underway about how to leverage the ILS markets to reform the NFIP, which racked up over $20 billion debt to the U.S. Treasury after Hurricane Katrina and Superstorm Sandy.

So what’s attracting investors to Florida’s hurricane risk?

Cat bonds and other ILS products meet two needs, say industry experts. For investors, they represent a new and attractive “non-correlated” asset class, meaning that the chance of a hurricane hitting Florida isn’t directly tied to performance of the overall economy. The risks associated with Florida hurricanes may be above average, but that also means that they’re potentially high yielding as financial products. And that risk is a generally well-known quantity to investors, who point to the availability of historic data and the growing sophistication of catastrophe risk models, which are used in the industry to gauge how different catastrophic scenarios could impact a given set of insured properties. 

There’s a benefit for insurance companies, too. Florida insurance companies are active cat bond sponsors today, largely because they offer access to more affordable cover, relative to traditional reinsurance. Although cat bonds require significant upfront expenses -- like risk modeling and deal structuring -- the investor interest in cat bonds has been strong enough to push overall reinsurance prices down in recent years. Many Florida insurers are taking advantage of the cheaper reinsurance market to “play it safe” and expand their overall coverage up to a 1-in-250 year storm. That may better insulate their Florida policyholders in the event of an unusually strong hurricane season. 

The fact that Florida hasn’t seen a major storm in 10 years is what’s “making this market viable and capital available,” according to Lynne McChristian, Florida Representative for the Insurance Information Institute.  “When we have a major storm, that market will restrict. Everybody knows it. It’s a roller coaster ride. It will go up on and down, like it always has in the past. And in a couple of years, it will come back,” she expects.

Citizens has been one of the biggest players to take advantage of current conditions in the global cat bond market. By 2015, it was the single largest property insurer in Florida, holding about 600,000 policies with over $186 billion in exposure, according to state documents. And by the end of that year, the company held over $3.9 billion in private reinsurance coverage, including billions raised through cat bonds. In 2014 alone, Citizens issued $1.5 billion in catastrophe bonds through Everglades Re, the company’s Bermuda special purpose company, in what today remains the single largest cat bond deal of all time. 

State officials have also been taking advantage of the lull of Atlantic hurricane activity over the past several years to shrink the size of Citizens, which peaked in 2012 with about 1.3 million policies, through a legislatively mandated “depopulation” program. Through that program, the state offers Florida property insurance companies financial incentives to assume existing Citizens policies. 

Several “takeout” insurers, including Heritage, National Speciality, Safepoint and Southern Oak, have been some of the largest cat bond sponsors to date, according information compiled through Artemis, an industry resource that tracks such deals. This February, Heritage issued $250 million in cat bonds, for example. 

A leap of faith and hope for a more resilient market

At least one Florida local government insurer is also getting in on the catastrophe bond market. The Florida Municipal Trust, which is directly managed by the Florida League of Cities and provides several lines of insurance to small and medium-sized cities across the state, stuck its toe in the market in 2013. The “Sunshine Re” deal provides $20 million in hurricane coverage for the Trust’s $9 billion municipal property insurance pool through May 2016, when the three-year deal expires.

Getting Sunshine Re done took “a leap of faith,” says Jeannie Garner, Senior Director of Insurance and Financial Services. The issuance provided a way for the Trust to diversify its sources of reinsurance coverage, which already includes about 40 partners in Bermuda, London and beyond, she explains. 

Building new investor relationships gives the organization a “chance to be seen after a (catastrophic) event,” when the reinsurance market may be much more risk averse, and reinsurance coverage therefore more expensive, according to Garner. A rough hurricane season or fluctuations in the broader economy, like a significant change in interest rates, might change the overall character of the reinsurance industry. Those pre-existing relationships between insurers, reinsurers and investors can help “keep the door open,” she adds.

Speaking of her investors, Garner says “they’re balancing their portfolio just like I am. They want risk diversification.” Garner’s perspective resonates with a view reflected across insurance industry media, reports and prospectuses alike -- that by spreading risks around the world through financial markets, the global insurance industry may become more resilient to catastrophic events like hurricanes and earthquakes.

Closer to home, the Florida Office of Insurance Regulation conducts an annual Catastrophe Stress Test to see how serious hurricane scenarios would impact the financial health of the state’s property insurers. The amount of reinsurance that each company carries is one of the main variables the Office of Insurance Regulation uses to make an assessment. The stress test models each property insurance company’s book of business against three major historic hurricanes and evaluates whether or not they would remain solvent -- and able to process claims in a timely manner.

Results from the 2015 stress test show that all of the state’s insurance companies would survive a major 1-in-100 year storm with the financial reserves and reinsurance they have in place, which includes cat bonds. 

The Catastrophe Stress Test is one of several regulatory measures that the Florida Office of Insurance Regulation has taken to shore up the state’s property insurance market, which has seen no shortage of ups and downs after Hurricane Andrew and the double whammy of the ’04/05 hurricane seasons. 

“Insurance linked securities have dramatically changed the marketplace and we believe will benefit the Florida domestic market,” Florida Insurance Commissioner Kevin McCarty said during remarks at last year’s Florida Insurance Summit. That extra capital will ultimately make for a more stable, and ultimately affordable, Florida property insurance market, he argued. 

“One storm is not going to change Florida’s marketplace,” McCarty said during that event, expressing great confidence that the growing presence of investor capital in the reinsurance business is here to stay. 

Retooling cat bonds to build city-scale climate resilience

The growing availability and use of catastrophe bonds and other alternative reinsurance products may be improving the ability of Florida’s property insurance industry to withstand natural disasters in the near term, but can they help Florida communities to become more resilient to some of the longer-term challenges posed by climate change? 

According to James Rhodes, one of the minds behind a new resilient infrastructure initiative called RE.bound, the answer lies in part in how catastrophe bonds are currently designed -- and in how they might be adapted to incentivize individual cities and even neighborhoods to reduce their longer term risk exposure to climate risks.

Enter the resilience bond, a proposed financial product that would tweak the catastrophe bond model to provide “resilience rebates” to sponsors who invest in infrastructure projects that reduce their exposure to climate risks like sea level rise. A new report, co-authored by Rhodes and released by the sustainable design firm re:focus partners, describes how resilience bonds may one day provide cities with a new means to finance resilience infrastructure. 

The idea emerged through the RE.invest Initiative, a sustainable design competition that looked at how eight cities across the United States could reduce their climate risks through strategic infrastructure projects. One of the participating cities was Miami Beach, where sea level rise is a major concern. There, the project evaluated how a new city-wide sea wall could help reduce tidal flooding and coastal erosion.

Following the RE.invest Initiative, ''one of the things that became clear is that each of these projects was reducing exposure, but also creating significant insurance benefits,” Rhodes explains. “We started thinking about how to capture these insurance benefits to finance the projects.”

With support from the Rockefeller Foundation, the risk modeling firm RMS, and the global
The growing availability and use of catastrophe bonds and other alternative reinsurance products may be improving the ability of Florida’s property insurance industry to withstand natural disasters in the near term, but can they help Florida communities to become more resilient to some of the longer-term challenges posed by climate change?
reinsurer Swiss Re, the resilience bond model took shape. One of the key innovations underpinning the resilience bond model is the ability to use existing catastrophe risk models to analyze how specific infrastructure projects -- like that new sea wall around Miami Beach’s western shore -- might reduce the insured risks in a given area over time. Insurers and reinsurers already rely on these catastrophe models to price catastrophe bonds, explains Rhodes. 

In the interim, the resilience bond remains an idea on paper. This year, Rhodes and his colleagues will work with cities and industry players to refine the model. 

“There’s lots of interest, but this isn’t a one-size-fits-all solution. It may take a little bit of time to find the right fit in terms of applications,” Rhodes says. 

Officials in Miami-Dade County aren’t leaving the conversation there, however. In 2014, the Miami-Dade County Sea Level Rise Task Force’s final report included six key recommendations

One of those recommendations identified the insurance and reinsurance industry as a key partner in the creation of “long-term risk management solutions” for the region. James Murley, who was Vice-Chair of the Sea Level Rise Task Force and is currently the Miami-Dade County Chief Resilience Officer, has been facilitating a dialogue between local officials and major industry players like Swiss Re and Lloyd’s of London. The county plans to release a report on the initial results of those conversations sometime in the next few weeks, he says. 

Bringing it home: boutique climate risk modeling for Florida property owners

At least one Florida start-up is adapting same risk modeling approaches that the global reinsurance industry uses to price cat bonds to give consumers a deeper insight into how sea level rise might impact their individual property. Based in Plantation, Coastal Risk Consulting is marketing a new series of sea level rise screening tools for property owners in Florida and beyond, who can use them to “gauge their relative risk,” says Dr. Keren Bolter, the firm’s Science Director. 

Coastal Risk Consulting’s reports, which start at $99, offer a color-coded, FICO-like flood risk score at the individual property level ranging from green to red according to the property’s risk. According to Bolter, the product uses highly accurate LiDAR elevation data to offer a long-term portrait of how rising sea levels could impact an individual property in terms of “flood days,” including an analysis of “when, where and how deep that flooding will be over time.” 

Bolter suggests that the reports could help would-be buyers do due diligence on a property, help homeowners to better understand if and when they’ll need to get serious about fortifying their home for flooding over the life of their mortgage, or even be used by a local governments looking for an alternative way to study their vulnerable assets.  

“If you’re in the orange or red bands, you might want to consider adaptation efforts and pass off this information to an architect or engineer,” she explains. Hypothetically, those adaptation efforts could range from making drainage improvements on a site up to elevating an entire home. 

Enabling homeowners to more clearly understand and address their individual exposure to risk has long been a challenge for the state and federal governments, which offer various insurance-based incentives to individuals and local governments to reduce their natural catastrophe risks.

“The fact is, most of the responsibility falls on individual homeowners,” says McChristian of the Insurance Information Institute. She points to the Florida Department of Emergency Management’s wind mitigation program as one way to take action. That program offers insurance premium credits to homeowners who fortify their home, i.e. roof improvements, installing stor
m shutters, etc. 

It’s clear today, more than ever, that insurers and reinsurers play a key role in Florida’s climate and catastrophe risk management puzzle, be it in preparation for the next hurricane season or the eventuality of sea level rise. How far that influence extends into the future -- or into the realm of how and where we build our local infrastructure or retrofit our homes to adapt to climate change impacts -- remains to be seen.

Next in our climate change series, 83 Degrees Media will explore links between building design, land use, sustainability and climate resilience by tapping the savvy of a number of Tampa Bay area designers, architects and planners. Comments? Contact 83 Degrees Media. Follow us on Twitter @83degreesmedia. 

Links to 83 Degrees Media's series of stories on climate change:

Part 1 -- Tampa Bay Area scientists, policymakers plan for rising sea levels

Part 2 -- Preparing for climate change: Pinellas County, local towns take steps to get ready

Part 3 -- Is the global reinsurance industry making Florida more resilient to climate change, hurricanes?

Part 4 -- Tampa Bay real estate boom and climate change: 5 big insights

Part 5 -- Climate change: Across Tampa Bay, environmental organizations mobilize around sea level rise

Part 6 -- Rethinking Tampa Bay's water resources as the climate changes

Part 7 -- Retrofitting Tampa Bay for climate change: From understanding to action
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Read more articles by Zac Taylor.

Zac Taylor, Ph.D., is a Research Fellow at KU Leuven in Belgium, where he studies climate change adaptation in cities, with a focus on real estate and finance. He earned his Ph.D. at the University of Leeds in the UK and holds degrees in urban planning from U.C. Berkeley and the London School of Economics. You can reach him on twitter @zacjtaylor.