Will Reinsurers Sustain a Direct Hit From Hurricane Harvey?

While predictions and analyses abound regarding the potential hit from Hurricane Harvey direct insurers may take, the potential impact to reinsurers has received considerably less attention. In the aftermath of this historic storm, some are beginning to ask, “will Harvey hit reinsurers where it hurts?” The answer is: “it depends.” For some reinsurers, including the reinsurers of the National Flood Insurance Program (NFIP) and reinsurers with exposure to auto risks, the storm is all but certain to deal a significant blow. For others, however, Harvey may not pack the same punch. Uninsured flood losses and/or high attachment points may shield many reinsurers from the worst of it. For those reinsurers that are exposed, the way in which ceding carriers aggregate their claims could be crucial to determining the overall reinsurance exposure. 

NFIP Reinsurers Find Themselves In the Eye of the Storm

Back in January of this year, the Federal Emergency Management Agency (FEMA) secured reinsurance for NFIP in an effort to shore up the NFIP’s ability to respond to extreme flooding events. With the knowledge that responses to prior storms (e.g., Hurricane Katrina and Superstorm Sandy) had left the Program in debt to the United States Treasury in the amount of $23 billion and realizing that major flood losses seem to be occurring with greater frequency, FEMA and the NFIP looked to the private reinsurance market as a way of transferring some risk and stemming the tide of outgoing dollars. While the 2017 reinsurance placement did not alleviate any of the NFIP’s existing debt, the aim was to insure that the NFIP did not find itself in an even deeper hole in the wake of additional flood events. Two pieces of legislation, the Biggert-Waters Flood Insurance Reform Act of 2012 (BW-12) and the Homeowners Flood Insurance Affordability Act of 2014 (HFIAA), paved the way for the NFIP to gain access to private reinsurance and capital markets. 

After placing $1 million in coverage with the private reinsurance market in September 2016, FEMA vastly expanded its use of reinsurance with the January 2017 placement. In that deal, which was brokered by Guy Carpenter, twenty-five reinsurers signed on to reinsure the NFIP for period from January 1, 2017 to January 1, 2018 to the tune of $1.042 billion. In exchange for $150 million in premium, the NFIP’s reinsurers agreed to cover twenty-six percent of losses between $4 billion and $8 billion arising from a single flooding event. The program reinsurers include both foreign and domestic companies.

With early estimates suggesting that covered NFIP flood losses could be in the range of $7 - $10 billion (or more), the NFIP’s reinsurance program is likely to be tapped, if not exhausted. This is good news for the NFIP, but decidedly bad news for the NFIP’s twenty-five reinsurers, who may be looking at a collective payout of over $1 billion. If there is a silver lining, however, it is that the reinsurance exposure to the NFIP losses will be split among the twenty-five reinsurers, and no single reinsurer will take the full hit. 

While Hurricane Harvey will go down in the history books for a number of reasons, it may come to be remembered by the insurance industry as the storm that prompted even greater participation by the NFIP in both the private reinsurance market and the market for insurance-linked securities (ILS). After the January 2017 reinsurance placement and prior to Harvey, legislators had been pushing for FEMA to be empowered to cede even more of the NFIP’s flood risk to private reinsurers and to take advantage of other risk transfer opportunities. To the extent that the NFIP obtains a sizeable recovery in connection with Hurricane Harvey, calls for this type of legislation are likely to become louder. 

The NFIP is not the only government-created insurance program that has reinsurance standing at the ready in response to Hurricane Harvey. The Texas Windstorm Insurance Association (TWIA), which was created by the Texas Legislature to provide coverage in coastal areas of Texas where windstorm insurance is not reasonably available, reportedly has a $2.1 billion reinsurance program in place in additional to various catastrophe bonds.

Beware of Exposure to Auto Risks

Harvey is also likely to be painful for reinsurers with significant exposure to auto risks. In a sector that was already struggling with negative underwriting trends prior to the storm, claims are mounting quickly – hundreds of thousands of them. There is no question that Harvey was the “perfect” storm in terms of generating auto claims. First, the all-out deluge that Harvey brought with it submerged cars, causing flood damage which is covered under most comprehensive auto policies. Given the magnitude of the flooding, a high percentage of claims are likely to be total losses. Second, the heavily auto-dependent nature of the areas affected by the storm meant that there were simply more cars to be destroyed by Harvey’s floodwaters. Third, the nature of the official response to the storm may have contributed to additional auto losses. In response to the threat posed by Harvey, officials discouraged a mass exodus from potentially affected areas and instead recommended that the population shelter-in-place. As a result, fewer people (and their cars) left the area for dryer ground. 

Insurance industry experts, including Warren Buffet of Berkshire Hathaway, have predicted that Harvey’s hit to the auto insurance sector will be significant. In a recent CNBC interview, Buffet indicated that Geico, an auto insurer under the Berkshire Hathaway umbrella, writes ten percent of the auto coverage written in Texas and is likely to sustain losses that rival those that arose out of 2012’s Superstorm Sandy. While auto losses to larger, well-diversified insurers may be extensive, for regional or local auto carriers, the losses may prove to be catastrophic. 

Uninsured Losses

Because a significant portion of Hurricane Harvey’s destruction arose out of flooding unrelated to any wind damage, it is very likely that a high percentage of the overall economic damage arising out of the storm will be uninsured. While flood damage is covered under most comprehensive auto policies, it is typically excluded from most homeowners’ policies. Unless homeowners are covered under the NFIP, they are likely out of luck. Additionally, reinsurance agreements may also contain their own flood exclusions. Thus, reinsurers (other than the reinsurers of the NFIP) with exposure to homeowners’ losses are likely to emerge relatively unscathed. 

Reinsurers with a significant exposure to commercial property risks, however, are more likely to face at least some exposure from Hurricane Harvey, although flood may either be excluded or sublimited under these policies as well. Between flood and wind damage in the commercial and energy sectors, some reinsurers, including UK-based reinsurers, may take a significant hit. 

Some pundits have suggested that the brunt of Harvey will be borne by direct insurers because of high reinsurance attachment points; however, the extent of reinsurers’ exposure could be driven by a number of factors that are still playing out, including the manner in which ceded claims are aggregated for reinsurance purposes. 

Aggregation and the Storm that Would Not End

Harvey was a storm that simply would not go away. The hurricane made its initial landfall on August 25, stalled over Texas dumping an astounding volume of precipitation, and made a final landfall in Louisiana on August 30. According to Colorado State University tropical scientist Dr. Phil Klotzbach, Harvey spent an eye-popping 117 hours as a named storm following its first landfall. Depending upon when one began measuring, the hurricane’s duration – or the duration of its effects - could be viewed as having lasted even longer. Interesting interpretive issues for contracts containing “hours clauses” may arise, particularly if the storm is interpreted to have exceeded the timeframes provided for in these clauses.

The length of the storm is just one of the factors that may impact the “number of occurrences” analysis, and relatedly, the aggregation of ceded claims. Other issues that may factor into the occurrences analysis could include Harvey’s multiple landfalls in differing locations, variations in the storm’s intensity over its lengthy duration, and the possibility that levee breaches or decisions by officials to release water from municipal reservoirs could be viewed as separate causes of loss. 

Conclusion

While Hurricane Harvey has (thankfully) passed, its lessons for the reinsurance industry remain to be learned. This time around, the fallout for reinsurers is likely to be felt by some more than others. 

Kristin Suga Heres is a partner in the Boston office of Zelle LLP. Her practice focuses on the resolution of insurance and reinsurance coverage disputes.