Reinsurance: A Many-Layered Thing
As Hurricane Milton unleashed its fury on Florida’s Gulf Coast, spinning off inland tornadoes, conspiracy theorists including Marjorie Taylor Greene and others were busy spinning bizarre fables on the social platform X, including that the government had “geo-engineered” the storm and that Federal Emergency Management Agency (FEMA) aid was being distributed along racial lines. In North Carolina, such fictions stimulated a misguided, Trump-inspired militia to go on the warpath against FEMA. These stories consumed so much oxygen that FEMA published a “Hurricane Rumor Response” page to debunk them.
Yet another myth that has gained credence is that climate change will deliver a knockout punch from which insurers will be unable to bounce back. In fact, virtually every serious media outlet has propagated in its articles the notion that climate change poses an existential threat to the insurance industry and that insurers (especially those in Florida) will exit the insurance business, pick up their ball, and go home. Representative stories include a March 2024 BBC article that asked, “What happens when insurance companies simply stop insuring?” The Wall Street Journal and numerous other trusted sources including CBS, Vox, Financial Times, and The New York Times also advance this gloom-and-doom message.
Wall Street Speaks
The reality is that insurers, especially those with a focus on Florida risk, are actually able to get up before the 10-count because they protect their balance sheet with large reinsurance purchases. Reinsurance is a shock absorber for insurance companies. Primary insurers pay premiums to reinsurers to smooth results, reduce volatility, provide balance sheet inoculation, and give confidence to the main arbiter of investor confidence: Wall Street. For example, on Oct. 21, Universal Insurance—one of four publicly traded insurers in the Florida market—traded at $19.38 per share, not far from its 52-week high of $23.27 and much higher than the 52-week low of $13.56. On the same day, another Florida insurer, HCI Group, traded at $116.26 per share, well above its 52-week low of $55.83 and close to its all-time high of $134. It appears that investors are running toward Florida risk rather than away from it.
Multi-Layered Protection
A look under the covers at HCI’s reinsurance protection shows how it cushions the HCI balance sheet. HCI wrote $766 million of gross insurance premium in 2023, paying reinsurers $270 million (or 32.4 percent of its gross premium) for reinsurance protection. Such a large outlay for reinsurance is consistent with other Florida-focused insurance companies, which, on average, cede approximately 60 percent of their premium to reinsurance companies. HCI announced on Oct. 16 that it expects to pay $600 million to $750 million for losses from Hurricanes Debby, Helene, and Milton. It reported further that after HCI it would still report a profitable third quarter from the cushioning impact of reinsurance.
The smaller the insurer, the higher the cession to the reinsurance market. For example, Olympus Insurance paid 86.9 percent of its 2023 gross premium to reinsurers to protect its balance sheet.
Insurance companies typically have complex reinsurance programs. The structure is visualized as a tower, with different reinsurers attaching at different heights like floors in a skyscraper. The primary insurer retains a certain limit, and the reinsurers’ limit is triggered when that retention is exhausted. Some reinsurers are lower in the tower; some are higher. And because reinsurers take on risk from many insurers, they secure protection for their own balance sheets by purchasing retrocessional reinsurance (commonly called “retro”), which is reinsurance for reinsurers. Reinsurers purchasing retro are retrocedents who cede to retrocessionaires like hedge fund D.E. Shaw.
HCI’s reinsurance structure consists of two towers, depending on the product and geography. Like other Florida-focused insurers, HCI cedes risk to dozens of reinsurers. There is a mandatory cession to the Florida Hurricane Catastrophe Fund, managed by the State Board of Administration. Above that layer, it cedes to reinsurers at Lloyd’s of London, in Bermuda and Switzerland, and at reinsurance giant Berkshire Hathaway in the United States.
HCI also cedes risk to its own Bermuda-based reinsurance subsidiary, Claddaugh Casualty Insurance Company. To make matters more complicated, Claddaugh participates in one of the columns across multiple reinsurance layers, geographies, and perils.
So to paraphrase the 1950s hit movie and song “Love Is a Many-Splendored Thing,” reinsurance is a multi-layered thing—and, when it keeps insurance companies from going under, many-splendored as well.