World’s climate risk capital: a natural progression for Bermuda
The story of how Bermuda evolved into the natural catastrophe risk capital of the world has its roots in late August of 1992. It was then that Hurricane Andrew caused such devastation in the southeastern United States that it forced the insurance industry to change for ever the way it managed catastrophic risk.
Category 5 Andrew ripped a path of destruction across the Caribbean, Florida and the US Gulf Coast, leaving 65 people dead and towns razed. At the time it was the most expensive natural disaster in history, generating $15.5 billion in property claims, or about $26 billion in today's dollars, according to the Insurance Information Institute.
Thirteen US insurers folded in 1992 and 1993, primarily as a result of Andrew, leaving a hole in industry capacity to cover catastrophic risks. In the months after Andrew, a slew of catastrophe reinsurers emerged in Bermuda to meet the challenge. The sudden influx of capital and expertise became the foundation of an industry in which Bermuda is today a world leader.
Over the past three decades, Bermuda re/insurers have paid out tens of billions of dollars in catastrophe claims all over the world and they continue to build on that track record of dependability. A survey released by financial regulator the Bermuda Monetary Authority found that Bermuda re/insurers incurred $19 billion in gross claims from typhoons in Japan and wildfires in California and Australia during the three-year period from 2017-2019 alone.
Back in 1992, nobody had been ready for damages on Andrew's scale and the insurance industry was no exception. It highlighted a basic weakness, that insurers were retaining far more risk than they realised.
The Class of 1993 heralded a more scientific approach, a time when insurers and reinsurers stepped up their risk management capabilities and made themselves more aware of their loss exposures. The response to Andrew created a blueprint for raising reinsurance capital in the wake of catastrophes and established Bermuda, a place from where the capital could be efficiently and rapidly deployed, as the place to do it.
Ian Branagan, RenaissanceRe's group chief risk officer, who also co-chairs the Risk Modelling Steering Group of the Insurance Development Forum, said: “The companies that formed in Bermuda after Hurricane Andrew brought new computing, data and science to the understanding of natural hazard risk for its pricing, capital allocation and risk management. That was a dramatic change from the pre-Andrew industry underwriting practice.
““Through that focus from starting and managing a business based on more comprehensive risk insight, those organisations were, by definition, in touch with science and were able to use high-end computing techniques to perform the analytics required to support the business.
“That meant that increasingly the research carried out in academia was being brought in to be used in a real business environment. That enabled both further development of risk understanding and the promotion of further research. So it was a pretty significant contribution to development of cat modelling.”
Mr Branagan said the earliest catastrophe models, dating back to 1980s, were all based solely on statistics derived from historical data. Useful data on most meteorological hazards date back to the 1920s, while patchy records go back further for North Atlantic hurricanes. Models based on incomplete data were likely to underestimate frequency, he said.
“I think the biggest change in the last 25 years in catastrophe modelling has been the move towards the use of physical models as opposed to just historical statistical approaches,” Mr Branagan said.
“With the computational power that we can now harness, and the emergence of large-scale numerical models that integrate the physics of the ocean and atmosphere, our ability to characterise these phenomena is much more complete relative to the past.”
Today's models are “more physics, less statistics”, Mr Branagan said, and are better suited than their less sophisticated predecessors to estimating the effect of climate change on weather patterns and the frequency and severity of natural hazards such as hurricanes, rain, hail and wildfires.
“There are short and longer-term signals in the data that track the influence of ocean and atmospheric cycles, for example the El Niño Southern Oscillation or sea surface temperature patterns in the Atlantic, which modulate the frequency and severity of extreme weather patterns,” Mr Branagan said.
“And our global climate is now changing at a rapid pace, so understanding and representing this important non-stationary driver is critical to the parametrisation of forward-looking models.”
Historical data become a little less relevant to models as the climate changes. “It makes physical models much more important to our work in characterising frequency and severity — the climate variability and weather outcomes of the last ten years and the next 50 do not look like they did in 1900s,” he said.
Mid Ocean Re was the first reinsurer to form in Bermuda after Andrew, the brainchild of Robert Newhouse and Bob Clements, who recognised the vacuum in the property-catastrophe market. Marsh & McLennan and JP Morgan joined forces to found the company, which was up and running by November 1992, with $350 million in capital. Mid Ocean Re wrote $200 million in premium in its first six months.
In 1993, a host of others came into the market, including two that survive as trading entities to this day: RenaissanceRe, which was supported by capital from USF&G and Warburg Pincus, and PartnerRe, the result of Swiss Re's collaboration with US investment bank John Head & Co.
Centre Cat, LaSalle Re, International Property Catastrophe Re, Tempest Reinsurance, Global Capital Re, Compass Re and Starr Excess Liability also drew investments from insurance brokers and insurers, investment banks and private equity. In total, Bermuda's Class of 1993 raised $4.8 billion.
Another wave of new Bermuda companies followed in the wake of the September 2001 terrorist attacks on the US, raising $8.5 billion in capital, bolstering the island's reputation as a global reinsurance hub. The Class of 2001 included the likes of Allied World, Arch Capital and Axis Capital, as well as Aspen Insurance, Endurance Specialty Holdings, Platinum Underwriters and Montpelier Re.
And after the two devastating Atlantic hurricane seasons of 2004 and 2005 came the Class of 2005, a group that attracted $13.3 billion from investors. Among them were Amlin Bermuda, Ariel Re, Harbor Point, Lancashire and Validus.
A significant development in 2005 was the rise to prominence of sidecars, which accounted for nearly $5 billion of the new capital. These were special purpose vehicles to provide extra capacity to their insurer or reinsurer sponsors to underwrite particular risks, usually for a specified time. Much sidecar capital came from hedge funds and private-equity firms, giving the capital markets short-term options for reinsurance market exposure, while providing reinsurers with greater flexibility to meet fluctuating market conditions.
Sidecars were the forerunners of insurance-linked securities such as catastrophe bonds, the next major development in the evolution of the Bermuda market.
This securitisation model allows traditionally insurable risks to be transferred to the capital markets and is most often used for specified types of property-catastrophe risk. About 85 per cent of the global outstanding issuance of $41 billion in ILS at the end of 2019 was listed on the Bermuda Stock Exchange.
The island is also home to ARC Insurance Company Ltd, the financial affiliate of the Africa Risk Capacity insurance pool, which provides natural disaster coverage to help African countries meet the needs of people impacted by natural disasters. Being at the centre of climate risk management for the developing world is a natural next step for Bermuda.