Winds of Change

In the wake of hurricanes, even insurers must reassess their risk exposures.

Weather Eye

Wausau Insurance Cos. similarly absorbs more risk than the average corporation. “We typically take a significant risk retention and then cede off layers above that to reinsurers,” says Scott Names, CFO of the Wausau, Wisconsin-based commercial- property and liability insurer, with $1 billion in 2004 revenues. “It varies by line, but our practice is to take higher retentions where we feel they are appropriate, and then reinsure the rest.”

The cost of reinsurance on the open market plays a role in how much risk these insurers are willing to retain on their balance sheets. “In some cycles, reinsurance is very cost-effective; if we can protect our balance sheet at minimal cost, we will,” says Names. “On the other hand, if the reinsurance market is hardening up and prices are outside what we feel is appropriate, we’ll retain more risk internally.”

Can noninsurance companies also skip over conventional insurance and go directly to the reinsurance market? “They would need to form a captive insurance company in order to cede risks to reinsurers,” explains Paterson of Fireman’s Fund. “Certainly, if they have a very good risk-management department, they should [consider] forming a captive.”

In the end, all of the insurers we spoke with keep a constant weather eye on property risk. FM Global’s vigilance, for example, gives it the confidence to bear $75 million of natural-disaster risk on its balance sheet. “If we see a deficiency in one of our properties from a risk standpoint, we attend to it immediately,” says CFO Burchill.

Hence, the company’s bold self-insurance strategy. Says Burchill: “It may sound strange coming from an insurance company, but we firmly believe that the majority of all losses are preventable.”

Russ Banham is a contributing editor of CFO.

Ultimate Coverage

Tapping the capital markets for disaster protection.

Catastrophe bonds, a rarely used vehicle for managing disaster risks, have attracted more interest in the wake of 2005′s hurricane season. To date, only three companies — Tokyo Disneyland, the French utility EDF, and Vivendi’s Universal Studios in Los Angeles — have issued them. The bonds are issued via special-purpose vehicles (SPVs) — legal entities that hold the capital raised from investors, either to pay them off when the bond matures or to pay off the companies if the bond is triggered by a natural disaster, such as wind speed above a certain threshold or an earthquake intensity exceeding a specific number on the Richter scale. (Vivendi’s $175 million bond, for example, is linked to earthquakes at various locations around Universal Studios.)

The strategy has appeal for these companies because of their concern over the ability of insurers and reinsurers to pay up in the event of a truly catastrophic disaster, such as an earthquake toppling much of Los Angeles. Payment is not an issue with a catastrophe bond, because the money is held by the SPV.

Swiss Re Capital Markets, which co-underwrote two out of the three transactions, says that since the hurricanes, it has been in talks with a few other companies about the strategy. There is a limit, however, to this application. “Many companies cannot meet the minimum financial thresholds to make the bond viable,” says Judy Klugman, a Swiss Re managing director in New York.

“To do a capital-markets transaction, you need a minimal notional amount being transferred, which typically is in excess of $100 million,” she says. “There aren’t that many companies with manufacturing plants worth that much in a disaster-prone area, other than energy companies with expensive facilities onshore and offshore [in the] Gulf of Mexico, which are actively looking at this as an alternative. They see the capital markets as a great complement to traditional insurance.” — R.B.

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