Self-insurance grows for catastrophe-exposed properties

More employers are self-insuring their U.S. coastal property risks, but not necessarily because they want to.

Following the record hurricane seasons in 2004 and 2005, substantial rate increases and reductions in insurance capacity for catastrophe-exposed property risks have forced buyers to assume more risk. Whether that increased risk retention takes the form of higher deductibles, lower limits or other changes to terms and conditions, policyholders are not able to transfer as much risk as they could two years ago, brokers, consultants and risk managers say.

As a result, buyers are looking at captive insurance to soften the blow and some are turning to quota-share arrangements within layered programs to save on premiums, brokers say.

New property catastrophe capacity coming into the market, however, should provide some relief for buyers and could ultimately result in more affordable risk transfer, property experts say.

And for most buyers with coastal property exposures, that would be welcome news.

"The '04 and '05 season has left us with breathtaking deductibles that have been foisted upon us by the insurance companies. Although there is capacity out there, they want to make sure the insured has a lot of skin in the game," said John Phelps, director of risk management for Blue Cross & Blue Shield of Florida Inc., which is based in Jacksonville, and also has offices in Fort Lauderdale and Miami.

Mr. Phelps said although the health insurer's windstorm deductible went from 2% of property value per location to 5% in 2005, and its aggregate windstorm deductible went from $1 million to $1.75 million in 2005, there was "no sense of urgency" to establish a captive to handle it. "We can handle it through our balance sheet at the current time. But it's always an alternative out there and the more we're asked to retain in both the property and liability lines, the more we think about it," he said.

"Certainly the dramatic increases in pricing and dramatic reduction in capacity for that coverage has led clients to rethink their risk-taking willingness," said Ed Koral, senior manager—actuarial and insurance solutions for Deloitte Consulting L.L.P. in New York. "These are people who have not recently had to make risk retention decisions for this type of risk, and now the market is forcing them to rethink and they are retaining more risk."

Necessity not strategy

Indeed, "last year was really the first year that people started taking meaningful plugs of capacity on a self-insured basis," said Alexandra S. Glickman, area vice chairman for Arthur J. Gallagher Risk Management Services in Glendale, Calif. "It, however, was more of a case of self-insuring as a necessity rather than anything that was a pure strategy."

But in those cases where buyers are strategically turning to captives to self-insure their coastal property risks, they are not looking to self-insure the entire exposure, Ms. Glickman said. "They're using it to take small (chunks) of capacity so that the layer pricing doesn't get completely thrown off track," she said. "That's the smartest way to approach it, because the last thing you want to do is bankrupt a captive because you then have to reload it."

Joe Siech, executive managing director of Beecher Carlson in Atlanta, said he's seeing clients "use their captive to quota share parts of layers to achieve premium reductions that aren't readily available by taking higher deductibles."

"In this market, there's not a lot of credit for taking higher retentions because underwriters need to get a certain price per million to feed their (catastrophe) models and new capital requirements," he said. So rather than go from, say, a $500,000 to a $5 million deductible to try to save on premium, buyers are turning to their captives with quota-share arrangements.

But captives are not necessary for such a strategy, according to Gallagher's Ms. Glickman.

She recommends "vertical quota-share" arrangements to those clients that are having difficulties in securing property coverage, have the financial wherewithal to absorb more risk and do not have loan covenants on their properties.

Under this type of self-insured arrangement, buyers assume a certain amount, such as 10%, of every layer of coverage above the deductible, similar to coinsurance, she said.

So if a risk manager needed to secure $100 million of wind coverage, the most the buyer would have to pay out in a $100 million loss would be 10% or $10 million, she said. Buyers "participate like any other insurer on those layers."

A captive is not necessary unless the insured wants to charge back the premium to a third party, she said.

According to Mr. Siech, while captives have benefits and should be "explored," they are "not for everybody." A lot of clients, he said, end up having lender requirements that dictate whether they need a certain level of insurer security in place, which can be "a bit problematic using a captive" because few are rated by rating agencies. In those cases, a fronting insurer would be required and "by the time you get a front and pay fronting costs, it's going to be more expensive at the end of the day."

Long-term view

At the same time, Mr. Siech said, buyers need to take a long-term view when they become an active risk participant within a coastal property captive arrangement.

"Unlike a lot of casualty risks that have a lot predictability around them, property risks just don' t have that," he said.

Brokers are optimistic, however, that buyers soon will see some relief in coastal property pricing as new capacity has come into the market.

"Most clients with exposure there don't want to self-insure anymore, but they're being forced to," said Jill Dalton, managing director for Marsh Inc.'s property practice in New York. "We're hoping that in 2007 we're going to see some relief in that because of the light (2006) storm season and new capacity coming into the market."