Florida fund goes cold on reinsurance; may fuel $2.5-$3 billion demand hike

The Florida Hurricane Catastrophe Fund (FCHF) has decided not to buy private reinsurance in 2009 or renew the put option it bought from Berkshire Hathaway, The Insurance Insider understands. However, reforms to the Fund’s temporary increase in coverage limit (TICL) could boost demand for increased limits of indemnity from the private reinsurance market to the tune of $2.5bn-$3bn.

The recommendation not to engage with the private financial markets at this time came from the Fund’s team of financial advisers, lead by Raymond James & Associates. It appears the advice was prompted by a number of factors, including the high cost of prospective reinsurance cat pricing and its hybrid capital market alternatives. This was coupled with the recent recovery in the municipal bond market, evinced by the state of California’s recent ability to raise over $6bn of tax-exempt bonds in late March 23, 2009 – despite coming shortly after that state’s credit rating was downgraded.

California’s recent experience has persuaded the Sunshine State that it would be able to secure an additional $5bn in post-event bonding if needed, bringing its total post-event bonding capacity to approximately $8bn.

However, The Insurance Insider understands that despite the reduction in the funding shortfall – previously calculated in October 2008 to be in the region of $18.5bn, or a claims-paying shortfall of around 50 percent of its insurance obligations – available resources still wouldn’t close out the obligations of the $16bn mandatory layer of the Fund. This would leave buyers of the excess TICL layer, which was introduced in 2007, facing financial uncertainty.

The Insurance Insider also understands that the FCHF’s tender for 2009 put option terms did not see any meaningful investor interest.

Last year, the fund bought a $4bn put option from Berkshire Hathaway at a cost of $224mn, after concluding that the cost of traditional reinsurance was too high. The option would have obliged Warren Buffett’s company to purchase $4bn of post-event cat bonds at pre-agreed pricing in the event of a major hurricane.

The FHCF is only obliged to pay out what it is financially able to do so, which means any Florida insurer buying into the TICL layer would be effectively at the mercy of a potential federal rescue were a large hurricane to strike.

Assessing potential demand from insurers who are looking to sidestep the TICL, Bryon Ehrhart, CEO of Aon Benfield Analytics, explained to The Insurance Insider that the key issue depends on what happens with the Florida legislature’s current attempts to reform the TICL.

If, as has been mooted, the TICL were scaled down by a third for the 2009 year, he said that Aon Benfield would expect incremental demand in limits of $2.5-3bn coming back into the private reinsurance market, if insurers fully replace what the TICL was covering

Since 2008, the FHCF has engaged reinsurance brokers Aon Benfield, Guy Carpenter and US Re, along with financial consultants from Goldman Sachs and JP Morgan, to look at solutions to shore up the fund.
Proposals studied included the purchase of up to $5bn traditional reinsurance in the private market – currently requiring indicative rates on line of approximately 27.5-35 percent – up considerably from the 17-24 percent rates put up a year ago.

Another proposal that won’t be pursued for the time being is hybrid bonds, where the provision of reinsurance to the FHCF would be accompanied by a commitment on the part of a reinsurer to purchase other FHCF financial products at pre-agreed terms.

The Insurance Insider also understands that the FHCF’s ability to access pre-event bond markets is also limited and amounts to approximately $500mn-$1bn, at premiums of 900-100 basis points.

The office of the Florida CFO Alex Sink was unavailable for comment, but forwarded a 12 March letter from Sink to the chairs of the state legislature’s insurance, business and financial affairs and banking and insurance committees.

The letter suggested a gradual reduction in the state’s Hurricane Cat Fund exposure through a multi-year phasing out of the TICL layer; increased investment in the MySafeFlorida home loss prevention scheme; a change in the renewal negotiations of Cat Fund reinsurance protections from spring to autumn; and a return to using state-owned Citizen’s insurance as a genuine insurer of last resort, with a phased return to actuarially sound pricing.

Raymond James & Associates did not respond to a request for comment at the time of going to press.