A.M. Best: Credit Woes May Cause Turbulence in Catastrophe Markets

May 19, 2008

The credit crunch in the U.S. financial markets that boiled over after the subprime mortgage meltdown may affect the ability of insurers and reinsurers that cover coastal areas to raise cash for claims if a major hurricane were to strike the United States this year, according to a special report released May 19 by A.M. Best.

Investors are showing a limited appetite for capital-market offerings designed to raise cash for claims payments, Best said. In addition, insurers’ exposure in hurricane-prone states to properties foreclosed and abandoned as a result of the subprime mortgage crisis has come under review. More than 500,000 properties in coastal areas from Maine to Texas have been foreclosed on due to the subprime mortgage crisis. Florida alone has more than 100,000 properties currently subject to foreclosure.

“Unoccupied, unsecured properties may be at increased risk in a storm, and financial stress on homeowners may increase the temptation to commit fraud,” according to the report, titled “Credit Crunch Clouds Outlook of Hurricane Insurers, Cat Funds.”

The report says insurers may not realize the extent to which their books of business are exposed to foreclosed properties. It said agents “can act as a line of defense for insurers” in this situation. “An agent’s mailing returned as undeliverable can be a warning sign that a policyholder is in financial trouble. News of a foreclosure, passed along to the homeowners insurer, can provide notice that the risk on a particular property just changed drastically.”

States like Florida, Louisiana and Texas, which rely on state-backed wind and coastal area insurance pools, may be most at risk. As a result of tightening credit, Florida’s largest insurer and state-run reinsurer, both of which depend on post-event bond offerings to cover any cash shortfall, may lack the funds to immediately pay all claims from a major storm, the report says.

A major hurricane has not struck Florida in two years, allowing private insurers to rebuild capital and surplus in that state after running up big losses in 2004 and 2005, and the Florida Hurricane Catastrophe Fund (FHCF) is looking for other ways boost liquidity and capacity. However, the report points out that “[i]nsurers could incur credit risk for their reinsurance recoverables tied to the FHCF if the fund has trouble raising money, while claims payments for Citizens’ policyholders could be delayed.”

Best warned that state and federal funds may be tapped if hurricane losses should exceed the ability of state-backed insurers of last resort to pay claims. Meanwhile, in addition to companies, municipalities are suffering from limited access to cash at affordable rates.

Hurricane forecasters have indicated the 2008 hurricane season may be busier than usual, the report says.

Hurricane Katrina in 2005 holds the record for the highest insured losses from a hurricane in the U.S. at $44.9 billion. Hurricane Andrew in 1992 comes in second, with $25.6 billion (stated in 2008 dollars) and Hurricane Wilma in 2004 ranked third with $11.4 billion in insured losses.

Source: A.M. Best, www.ambest.com

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