Reinsurance Why Have Cat Losses

Reinsurance

Why have CAT losses been growing? What differences do you notice in the nature of the risk now as compared to two decades ago?

CAT losses have been growing at an increasing rate due in part to higher frequencies in disasters. Not only have disaster occurrences been more frequent in recent years but the severity of these events has increased exponentially. With the increase in disaster magnitude, a corresponding increase in loss is usually the subsequent result. More importantly, the areas that disasters effect should also be taken into consideration. Many of the disasters of the early to mid-90's damaged many high value, wealth generating areas within the United States. These occurrences were also in the midst of the tech buddle which at the time was sending stock prices higher than there underlying market value. As a result, people were becoming wealthier. When this wealth was destroyed through natural disasters, insurance companies needed to compensate the individual according. Contrast this with the current state of the housing market. Many houses have lost nearly 50% of their peak value in 2007. Since many of these housing have lost value, insurance companies will pay less for there subsequent repair in the event of a disaster.

2. How do insurance companies manage CAT risks? How does National manage CATs?

Insurance companies mitigate risk through a systematic implementation of financial instruments. One such method is through reinsurance. Reinsurance allows the reinsured to cover a portion of their policy, thus reducing risk. In many instances insurance companies reinsure their policies through a multitude of insurance companies in an effort to provide further diversification. Essentially, by passing along the risk to the reinsurer, the insurer is providing a means of managing potential losses in the event of disaster. Another means of managing risk is through financial instruments such as futures contracts. Through these contracts, insurance companies could hedge against unaccounted for losses created from disasters. Finally, another method to manage risk is through geographic diversification. Generally speaking, certain natural disasters occur in certain regions of the country. For example, hurricane damage is predominating among the east coast of the United States. By having more low risk, high certainty policies in areas not prone to disaster, insurance companies can better cover losses that occur in areas predisposed to disaster. National manages CAT's through a combination of these measures. One method is usually not enough to completely diversify risk. In many instances, it is necessary to use a combination of methods in the event that one is more advantageous to another in a given situation.

3. What are the pros and cons of using insurance securities vs. reinsurance?

Insurance securities such as CAT bonds offer a higher rate of return for investors. Also, many of these securities are not linked to the financial markets which make them particularly attractive. By having a position in insurance securities, the individual is essentially diversifying a portion of the risk of the financial market. However, these instruments have inherently higher risk associated with them. As a result, an investor who is not meticulous in his or her research could lose sever amounts of wealth through the improper use of insurance securities.