Is the $575bn reinsurance industry risking a banking-style meltdown?
The earthquake in Nepal at the weekend is estimated to have caused between $2.8bn and $4.5bn worth of damage, but insurers are expected to cover less than $100m, according to the disaster analysis group CEDIM.
Between 1987 and 1993 the world’s six biggest storm catastrophes cost the industry over £20 billion in compensation. Global warming was seen by many financial institutions and corporations as a key factor in the increase in natural disasters. [Insurance and the environment: The Ethical Consumer, Mar/April 1996]. PCU data on reinsurance continues with 1995 figures released by Munich Reinsurance and FT’s 1998 reinsurance survey. It then took a more benign view of ‘catastrophe bonds’: “an efficient alternative to traditional coverage. Returns are higher than those from blue-chip corporate bonds, but the capital raised is used to meet the cost of disaster should one strike”.
In 2002 the Independent reported that the Financial Services Authority ordered ‘some UK insurers’ to abandon reinsurance agreements which it believes are mainly cosmetic attempts to hide liabilities. In 2001, Equitable Life had signed a reinsurance agreement which brought its liabilities down so that it could meet solvency requirements. It was also said that Equitable appeared to have written a letter to the reinsurer promising not to claim fully on its policy.
Unsatisfactory reinsurance was also discovered at Independent Insurance, which went into administration and was the subject of a Serious Fraud Squad investigation, which led to the imprisonment of several senior executives in 2007.
Yesterday, Alistair Gray of the Financial Times reported that Professor Paula Jarzabkowski of Cass Business School, a member of its research team, said mainstream insurers, who offer protection from earthquakes, hurricanes and other disasters, are potentially spreading risks to parties that did not fully understand them.
The team found that the industry has been making “dangerous” changes to how it is structured. The changes, which resemble those linked to the subprime mortgage crisis of 2008, include:
- packaging together catastrophe risks in a similar way to the carving up of subprime mortgages by big banks before the financial crisis – transferring risks through complex “bundled” reinsurance arrangements.
- and issuing securities such as catastrophe bonds, backed by pension funds and other capital markets investors – as an alternative to traditional reinsurance.
Fears were expressed that the victims of a costly catastrophe – such as an earthquake or storm that destroys large areas – could run into problems having their insurance claims paid. However it was later noted that a handful of catastrophe bonds, triggered only by a devastating event, such as that expected to occur once every 200 years, have paid out for insurers.
In a book to be launched this week, Making a Market for Acts of God, The Practice of Risk Trading in the Global Reinsurance Industry, the authors – Paula Jarzabkowski, Rebecca Bednarek, and Paul Spee – warn: “As other financial industries have collapsed, in part through their reliance on inaccurate models, so, too, reinsurance places itself at risk of collapse.
The emphasis appears to have shifted from the ’90s expressed imperative of addressing the root causes of many disasters to the financial management of compensation claims.
A policy of desperation?
Posted on April 29, 2015, in Economy, Environment, Finance, Planning, Vested interests and tagged "bundled" reinsurance, capital markets investors, Cass Business School, catastrophe bonds, Equitable Life, Nepal earthquake, pension funds, subprime mortgages, traditional reinsurance. Bookmark the permalink. Leave a comment.