Testifying before the House Committee on Financial Services on the future of the federal terrorism backstop Thursday, a reinsurance executive said the capital markets will not solve terrorism insurance capacity problems if the Terrorism Risk Insurance Act (TRIA) goes away.
Eric Smith, president and CEO of Swiss Re Americas, predicted, “We may never see a significant market for terror bond securitizations.”
The comment came after Smith explained why terrorism remains an uninsurable risk and gave some specifics on traditional reinsurance capacity, according to a written copy of his testimony available on the committee website. (See related article, TRIA Structure Will Change, But Renewal Expected: Analyst, for Smith’s discussion of insurability.)
Referring to the recent influx of capital into the insurance-linked securities (ILS) or catastrophe bond markets, he said that not only doesn’t the ILS market “substitute for traditional insurance,” but on the reinsurance side, “the ILS market has not been willing to underwrite risks that are not being underwritten by the traditional reinsurance market.”
There are several factors that make investors reluctant to buy terrorism bonds.
- First, there is a correlation between terrorism risk and the broader equity markets. Financial markets are sensitive to terrorism risk and the possibility of broader economic disruption.
- In addition, there is a greater potential for adverse selection. Those with the highest risks are more likely to seek coverage.
- Also, rating agencies have been reluctant to rate terror bonds because of the inherent uncertainty in determining the risk, which further restricts potential investor interest.
“As a result, to date, there have been no securitizations of property-catastrophe bonds solely for terrorism risk in the market despite this influx of capital.
“With terrorism risk largely uninsurable, we may never see a significant market for terror bond securitizations,” he concluded.
Addressing the capacity of the traditional reinsurance market, he said that the same challenges of insurability that face primary insurance companies have limited the amount of terrorism reinsurance capacity.
“The capacity we do offer supports our clients and the mandates that they must adhere to under TRIA,” he said, noting that the most recent estimate of the total amount of reinsurance capacity available for terrorism in the United States is between $6 billion and $10 billion—”well below the $27.5 billion insurance marketplace aggregate retention under TRIA and the $34-$35 billion cumulative insurer loss retentions.”
“As a point of reference, the total global capacity for natural catastrophe risks has been estimated as $300-$350 billion, with the U.S. commanding roughly 35-45 percent of this capacity,” he said.
Smith also noted that the reinsurance capacity that is available for terrorism in the United States generally is limited to conventional terrorism losses, “with virtually no capacity” available for nuclear, biological, chemical or radiological terrorism.
“Even for conventional terrorism, terrorism reinsurance may be further constrained within large metropolitan areas due to exposure aggregation challenges,” Smith said.
While the $6-$10 billion of reinsurance capacity is valuable to primary insurers as they manage their exposure within existing TRIA retentions, “the commitment that the federal government has provided to the terrorism insurance market through TRIA has given the reinsurance community the confidence in the market to offer this capacity.” If TRIA expires, the reinsurance capacity will go away, he said.