The Coastal Property Book After a Reinsurance Renewal
You are the chief underwriting officer of a mid-sized regional carrier. Your coastal homeowners book has $420 million of total insured value concentrated in two counties. Your catastrophe excess-of-loss treaty renewed on January 1 with a $50 million retention, a $400 million limit, and one free reinstatement at 100% additional premium. The treaty covers a single event, and the definition of event aggregates all losses from a 72-hour period. In February, a severe convective storm causes $38 million of gross losses. In July, a named hurricane causes $95 million of gross losses. In September, a second hurricane causes $60 million of gross losses. Your CFO asks whether the program is adequate and what the net retained cost of the year's catastrophe activity is. Your board wants to know whether the free reinstatement should be exercised before the September event, and whether the program should be restructured at the next renewal.
1. Calculate the net retained catastrophe cost for the year and explain how the retention, limit, and reinstatement interact.
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The February storm produces $38 million of gross losses, all below the $50 million retention, so the carrier retains the full $38 million. The July hurricane produces $95 million; the carrier retains $50 million and cedes $45 million, leaving $355 million of the $400 million limit and one free reinstatement available. The September hurricane produces $60 million; the carrier again retains $50 million and cedes $10 million, leaving $345 million of limit. Total net retained catastrophe cost is $38 million plus $50 million plus $50 million, or $138 million. The key insight is that the retention applies per event, not per year, so three separate events create three separate retentions. The free reinstatement was never needed because the July cession of $45 million and the September cession of $10 million together did not exhaust the $400 million limit. If a single event had exhausted the limit, the reinstatement would have restored coverage but at 100% additional premium, effectively doubling the cost of the layer for that event. The board should understand that the program's real weakness is frequency of retention events, not exhaustion of the limit.
2. The board asks whether the program should be restructured. What factors should drive the recommendation?
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Several factors point toward restructuring. First, three retention events in one year cost $138 million, which is nearly three times the single-event retention. A frequency-sensitive structure, such as an annual aggregate deductible or a second-layer drop-down, would reduce the cumulative retained cost. Second, the book's concentration of $420 million of total insured value in two counties means a single severe hurricane could produce losses well above the $400 million limit, leaving the carrier exposed above the treaty. The carrier should model a 1-in-100 and 1-in-250 year event to test whether the limit is adequate relative to the probable maximum loss. Third, the free reinstatement is valuable only if a single event exhausts the limit, which did not happen; the carrier may be paying for reinstatement capacity it does not need. Fourth, the 72-hour event definition could aggregate two closely spaced storms into one event, which would help the carrier by applying one retention, or could split a long-duration event, which would hurt. The recommendation should weigh the cost of additional limit against the reduction in retained frequency losses and the tail exposure above the limit, and should consider whether to buy a lower retention with a higher attachment or to purchase aggregate stop-loss protection.