As early as October 2021, the credit rating agency Fitch has been predicting double-digit increases in property catastrophe rates for 2022. Beginning with contracts renewing in January 2022, catastrophe-related lines of business can expect to see reinsurance rates increase by more than 10 percent, per Fitch.

This follows a year of insured losses approximating $100 billion in U.S. dollars, and expectations of an increase in both frequency and severity of natural catastrophe claims.

Around two-thirds of nonfacultative reinsurance renews in January, with strong focus on the European marketplace, and because of severe losses from storms and flooding in Europe, Fitch anticipates that, "…price rises should be most pronounced in Central Europe."

Other Fitch predictions are:

  • "We expect 2022 to be the fifth successive year of price rises, although we expect growth to be slower than in 2021 as nonloss-affected lines of business are likely to show a broadly stable price development"; and
  • "Attractive rates and healthy underwriting margins will continue to attract new capital, so that ample capacity will limit further price increases beyond 2022."

The good news is that Fitch believes recent property rate increases have been sufficient to compensate for higher inflation and inflationary trends such that inflation will begin to ease in 2022.

We think these increases may lead to more insurers seeking to transfer some risk through insurance-linked securities, such as catastrophe (CAT) bonds, and parametric triggers. In brief, insurance-linked securities (ILS) are security investments tied to insurance risks whereby insurance and reinsurance capacity can be increased by transferring specific risk to the capital markets.

The value of an ILS is influenced by whatever insured loss event is underlying the security. A property example would be an ILS that would free up an insurer's capital by covering windstorm or earthquake events for the term of the CAT bond. Investors would provide the insurer with up-front capital to fund the security value (determined by insured losses resulting from the covered event). In a CAT bond structure, the sponsoring insurer or reinsurer would form a special purpose reinsurance vehicle (SPRV) that issues the bonds to investors, invests the proceeds, and provides a reinsurance contract to the sponsor. If the designated underlying event (catastrophe) occurs, the SPRV uses the bond proceeds to reimburse the CAT bonds' sponsor according to the terms of the bond transaction. In this case, the investor could lose their principal and interest if the covered events exceed the total amount raised from the bond. If the specific event does not occur during the term of the bond, the bond investors recover their principal along with the agreed-upon interest. Investors can receive a higher interest rate from CAT bonds than from most other fixed-income securities, and the investor also benefits from receiving regular fixed-interest payments in return for holding the bond.

CAT Bond Example:

  • Insurance Company A issues a CAT bond covering earthquake events. The bond has a face value of $1,000.00, matures in two years, and pays an interest rate of 7 percent. The CAT bond investor would receive $70 each year and if no triggering earthquake occurs, the principal will be returned at maturity. The CAT bond raised $100 million in proceeds, which was placed in the SPV (special purpose vehicle).
  • The bond structure requires payout to Insurance Company A only if the total earthquake events exceed $500 million for the two years.
  • In year two, a series of earthquake events occur during the bond term with total insured losses of $600 million. This activates the bond payout at its value of $100 million, which is transferred from the SPV to Insurance Company A.
  • The investors who held the $1,000 CAT bond earned $70 in interest in year one, but lost their principal in year two. Insurance Company A reduced their cost for the earthquake losses from $600 million to $500 million by issuing the CAT bond.

Parametric insurance is a totally different risk transfer vehicle. It can perhaps be best thought of as a buyer protection arrangement up to an agreed-upon amount, triggered by predetermined parameters. Because there is flexibility in establishing what parameters will trigger payout, they can be set so that there are many different parameters triggering different amounts; it can be as simple as one parameter and one payout; for example, a 5.0 or higher earthquake event triggers payout; or as complex as many parameters with many payouts; for example, each 5.0 or higher earthquake event, with differing payouts depending upon the magnitude of the earthquake event. As soon as any one parameter is met, there is a payout of the predetermined amount – no waiting for the adjuster or loss estimates. There are many ways to design a parametric trigger, with the predictability of a fast payout when the predefined parameters are met.

Parametric insurance relies on a measurement of an event or index, such as temperature, wind speed, or other; as long as it is objective data, from a reliable data source providing consistent and timely measurement, it has available access to historical statistical data to allow for modeling, and it is correlated with the economic loss sustained. Since any index is imperfect in knowing the actual economic impact to the insured, parametric insurance has a residual basis, which is the difference between the payout and the actual loss sustained.

There are many different names and structures of parametric insurance solutions, including Cat in a Box, Cat in a Circle, Double Trigger, Single Trigger, Intensity, to name just a few. We will describe the most common, which is Cat in a Box.

In a Cat in a Box structure, a payout occurs if a catastrophe such as an extreme weather event (the 'Cat') occurs in a given, pre-agreed area (the 'Box' – which in practice can take the form of a square, rectangle or circle). The 'Cat' must meet the minimum pre-agreed intensity threshold and go through the 'Box' to trigger the payout. You may also hear this type of parametric insurance solution referred to as a 'double trigger' as it requires the catastrophe to occur in a predefined area (first trigger) and to be of a certain magnitude (second trigger). The "box" can be defined so that it is not limited to the insured's own locations, but could also include other infrastructure critical to the insured's supply chain. This provides clients with more flexibility as compared to traditional property damage business interruption policies.

Cat in a Box Parametric Example:

  • An insured high-rise condominium on the Florida coast wants to protect itself against losses from potential hurricanes of Category 3 or stronger, within a 50 mile radius of the property. Here, the 'box' will take the shape of a circle around the property, known as Cat in a Circle.
  • The parameters of the payout would be when a hurricane's track is: a) within the predefined area (the 50 mile radius); and, b) the hurricane's strength within the circle is at or above the predefined threshold of Category 3, as reported by a predetermined reliable party, such as the National Oceanic and Atmospheric Administration (NOAA).
  • In our example, the payout will be 50 percent of the predetermined limit of $10,000,000 for a Category 3 or higher hurricane happening in a 50 mile radius around the main condominium building. In its simplest form, there will be one payout only, regardless of how many hurricanes occur during the term of the parametric insurance. So for example, if a category 2 hurricane at 105 mph hits the condominium, there will be no payout. However, if a category 3 hurricane at 120 mph hits the condominium there will be a payout of $5,000,000, regardless of the amount of actual physical damage to the condominium.

In reality, there may be many different payouts depending on the predetermined wind speeds and category storms, with a percentage of the limit being paid out based on each of those parameters.

It is noted that with the recent Arthur J. Gallagher purchase of Willis Towers Watson, the company gained ownership of the private catastrophe bond issuance platform and ILS transformer vehicle, Bermuda based Resilience Re Ltd. Resilience Re was designed to also make accessing the cat bond market for capacity quicker and simpler; in part, through simplified processes and documentation for qualifying risks, offering clients access to dedicated reinsurance transformers along with standardized reinsurance and securitization procedures.

AJG already owns Horseshoe, via Artex Risk Solutions and Horseshoe has its own very successful reinsurance transformer and private cat bond or ILS issuance vehicle, Eclipse Re Ltd.

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