Kenneth Froot (professor of business administration at the Harvard Business School & author of The Financing of Catastrophe Risk) said his research shows that capital for traditional reinsurers is slowly being drained by large “catastrophe risk shocks” like Hurricane Katrina and the September 11 terrorist attacks.
Each time the reinsurance industry has its capital base “depleted” by a catastrophic event, Froot argues it costs the industry significantly more to replace that capital. The resulting pressure and the inability to raise prices quickly is pressuring reinsurance balance sheets.
“Every dollar in reduction of capital adds up to more than a dollar in market capitalization,” Froot said. “Every dollar of surplus adds to market value, but every time you lose a dollar in surplus you lose more because your market value has begun to fall and you become distressed.”
Additionally, the financial crisis that started in 2008 will likely push regulators to tax large conglomerates like reinsurance companies.
Froot cautioned that although traditional reinsurance may play a smaller role in risk transfer over the next several years, ILS structures like catastrophe bonds and collateralized reinsurance need to continue to evolve. He cited individual transaction costs, structural problems and transparency issues that need to be worked out for the industry to thrive.
