Are US insurers buying enough cat cover for the risks they're taking?

Here is an opinion that is likely to be popular with many readers but I think is nonetheless true. Many insurance companies in the US are not buying enough catastrophe reinsurance for the risks they are taking.

Twice in two years events that should not have been outside of any realistic disaster scenario planning have either threatened to, or actually, blown through available reinsurance protections at numerous companies.

In 2017, with Irma barreling down on a direct hit on Miami-Dade, real-time analysis predicted that multiple monoline Florida Homeowners insurers would blow through their reinsurance towers and be bankrupt within 48 hours.

That this did not happen is simply due to a last minute quirk of nature and a change of direction to a less impactful landfall site.

And in 2018, we have already seen four companies blow through their reinsurance following wildfires in California. This even though these programmes are meant to protect to at least a 1-in-100 year event to placate rating agencies and regulators.

Let us be honest about a few things.

First, it is simply a fact that model shopping and model manipulation is rife across our industry. To a large extent, management is able to get the result they want by switching models or by modifying factors in these models to their advantage. Second, how much scrutiny have the relevant gate keepers like regulators and rating agencies placed on how companies come to their estimates of cat exposure like  probable maximum losses?

Recent evidence, including two rapid fire downgrades after the wildfires by Am Best, suggests not nearly enough.

The third and worst part of this is simply a corporate governance failure. How many of these companies have been incentivized to do this by allowing management to take huge cash bonuses when the wind doesn’t blow, but guaranteeing little downside consequence to managers when disaster strikes?

This is one of the industry’s worst scandals that gets too little attention.

Statistically, for any given CEO, it is unlikely the big one happens on your watch. Your personal incentives are to extract as much cash out of a company as possible, while taking as little downside risk as possible.

If the big one happens, you still walk away with your cash while your investors go broke. If it doesn’t, you keep getting richer.

This absence of alignment or claw-backs is not just a failure of boards and investors in the US. It is explicitly underwritten and supported by the reinsurance industry.

It is their lust for premiums in a growth-starved market that has empowered many to play this game without putting their own skin in the game.

Explicitly, this type of game is much, much harder to play without the support of a willing reinsurance market. And this it is also bad for reinsurers to underwrite principles with little incentive to manage the downside risk.

If history has taught us anything in this business it is that it is better to be roughly right than precisely wrong.

We as an industry have allowed ourselves to become too slavish to self-reported modelled estimates, too trusting of an output that is easily gamed.

At best, we risk kidding ourselves with precision; at worst, we risk being fooled by deliberate confidence men (it usually is men) willing to bet the house on black, safe in the knowledge that the chips are free.

There is simply a virtue to a prudent margin of safety over and above modelled estimates. But that is a hard discipline to maintain when competitors are all pushing the envelope.

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