Weathering the Storm: Innovative solutions to provide insurance cover for severe convective storms (SCS)

Matthew Grant: John what challenges and what you’re seeing out there in the industry? 

John DeMartini: What we’re specifically talking about today are solutions for severe convective storm (SCS) events. Severe Convective Storms are experienced in the form of tornadoes, hailstorms, derechos and other straight line winds. 

The solutions we are talking about today are different, they are new and they are alternatives to the traditional property catastrophe reinsurance program solutions that are still currently available for the perils of hurricane and earthquake and others.

The characteristics of SCS make this a unique space and a unique challenge. If you go back a few decades SCS was not such an issue. Loss activity in this area was relatively moderate for many years. Reinsurance catastrophe programs attached incredibly low. On a model basis, many of the cat programs I saw had attachments below the modelled 10 year return period.

Aggregate covers were also readily available. You could buy a traditional catastrophe program with a lower retention, then top it off with an aggregate program. Basically, an insurer was transferring a very high percentage of the company’s SCS risk onto the books of reinsurers. Also, we didn’t have much inflation during those periods.

Two things have changed significantly. The first is the weather. And as you can see, in figure 1, losses from weather perils have increased seven times since 2009. It’s been a very different picture from what we experienced in prior decades.

We have had an enormous amount of activity, more losses, more severe losses, bigger hail, wind driven hail. This is hitting communities that have grown from small towns to suburban areas to large urban areas. So those factors, when combined mean that losses have risen tremendously.

And in Figure 2, as you can see, for 2023, SCS losses dwarfed every other peril. The weather has dramatically changed the picture in terms of the SCS as a peril.

The second factor that has arisen is that reinsurance for severe convective storm events has changed significantly.

There have been increases in catastrophe programs and Figure 3 shows a couple of quotes here that tell the story. Reinsurers are not interested in low attachment points for SCS anymore. And they are not interested right now in traditional aggregate covers.

We don’t see the appetite for either the lower retentions or the aggregate covers re-emerging. And to top it all off, we have inflation. Inflation impacts the cost roofing materials, siding materials, glass as well as increased cost of inflation in labor. 

These changes in the reinsurance offering’s means insurers have to buy at higher retentions. This is restricting some of the coverage reinsurers can offer to their insureds. Alternatively, reinsurers are charging higher deductibles, requiring higher loss recoveries, et cetera. So, we have a confluence of things coming together.

This means that a good deal of the risk for SCS is now falling back on the insurers. Many insurers have their earnings and surplus at risk right now to a far greater extent than they previously did. There have been a number of A M Best rating downgrades, approximately double the number in 2023 for downgrades than there were in 2022. These have been primarily driven by SCS loss scenarios and all of the factors that I just mentioned.

A number of insurers have actually gone out of business due to severe convective storm losses and the challenges they faced when trying to find reinsurance capacity and take on higher retentions. One example is Wisconsin Re, which unfortunately went into rehabilitation in 2023 an example of what can happen from the impact of severe convective storm losses. 

That’s why I believe that Demex has come up with some very interesting and very appropriate parametric solutions.

Matthew: Thanks, I think it’s quite extraordinary when you look back at that severe convective storm loss relative to all the other perils, because we hear a lot about wildfire, and we are very aware of hurricanes. It does remind me of the world 20, 30 years ago when hurricane losses were starting to get the attention of the rating agencies and the regulators. What are rating agencies going to be looking at into 2025?

John: the rating agencies want to know what the plan is. What are you as an insurer doing to mitigate this risk?  The insurers do have some choices. They can control the coverage they offer, the deductibles and the pricing of those products. They can put this formula in front of a rating agency like A M Best to show how they are going to improve their net underwriting results.

The other side of what rating agencies want to know is what insurers are doing to manage the fact that their reinsurance retention is higher. They will ask for example “you can’t buy as low as you used to, and you don’t have the aggregate cover you have anymore. What are you doing to transfer some of this very volatile risk?”

The third thing is that rating agencies are pushing insurers to diversify the footprints of their portfolios so that they don’t continue to grow in the highly concentrated areas where they may have been doing business 

Matthew:  Peter, can you tell us about Branch and how you’ve been working with Demex? 

Pete Vloedman: Branch insurance is a personal lines carrier headquartered out of Columbus, Ohio. We were formed in 2019 and since then we’ve expanded to 25 states, primarily in the Midwest and the South.

Our mission at Branch is to make personalized insurance more affordable, which in this type of market condition has been a real challenge. We’re organized as a reciprocal exchange, which is similar to a mutual, so our members are counting on us to charge appropriate prices for the insurance because they do share losses in real time with each other.

Matthew: You started off with a clean sheet at Branch from a technology and exposure perspective. What are some of the things that you need to be able to resolve to be able to continue to be a successful organization and support your clients? 

Pete:  As John highlighted, SCS has affected the entire industry over the last 10 to 15 years. The challenge for us has been, that we’ve got growth as well as change in climate. 

If I look at NOAA’s disaster data, which covers five decades worth of loss, the percentage of SCS loss as a percentage of overall billion dollar disasters was about 30% in the decade of 2010. Now it’s about 65%.  So doubling in that time. In terms of severity, you see a similar pattern. SCS losses in the eighties and nineties were about 20% of overall catastrophe losses and in more recent time it’s gone up to 40%, so about a 50% increase.

I spent most of my career as a reinsurer, designing protections for customers. And the challenge for insurers today is that reinsurers are trying to improve profitability after a lot of years of marginal profitability or losses. As they move retentions up, which is a smart thing to do as a protection seller, this impacts smaller companies, such as Wisconsin Mutual, that John mentioned and other smaller companies which have a surplus is less than a hundred million dollars. As aggregate covers went away over the last five years or so, which were a key component of protecting against frequency losses, it caused problems for these smaller insurers. There is now only limited pro-rata reinsurance available protect from high frequency losses.

A characteristic of SCS losses is that the average loss isn’t big enough to get into an insurer’s occurrence catastrophe program. They need something to handle that adverse frequency in their retention. And that traditional aggregate cover, which we’ve used for years, has gone.

Matthew:  So how do you respond to that?

Pete: There have been a number of technology solutions developed over the years. We looked at one of the first cat bonds to handle SCS in the early 2010s, issued by American Family, to learn from that. We think that Demex has now come up with a really neat atmospheric product that uses a model loss to handle the loss payouts.

With the Demex product a reinsurer can now price based on the atmosphere. They don’t need to price based on how their cedents manage their claims payments. They don’t need to adjust prices to charge for loss inflation. They don’t need to question if deductibles are high enough. Overall, we think it is a really good compromise between the traditional aggregate product and having nothing at all.

Matthew: When you were looking for this solution what kind of advice were you getting from your brokers and how did you come across Demex?

Pete: We needed a solution to address the frequency issue in our catastrophe program retention. Unfortunately, traditional indemnity aggregate cover was not available but Gallagher Re, our reinsurance broker, brought a number of other solutions to the table. 

A model loss solution, which I had had experience with going back to the 1990s, mostly in ILS (Insurance Linked Securities), was one concept we liked. Now Demex is bringing that model loss solution technology to the traditional market as well. This seemed a good fit given my comfort with how those covers work and the fact that we have a very standard personal lines book. A typical customer is single family rancher, 300,000 dollar coverage, we’re insuring chevys not cadillacs. A model loss solution works really well for this type of portfolio and personal lines 

Matthew How have things have been going for you in so far this year in 2024? 

Pete: The process that we went through with Demex to put the cover in place was very cooperative and iterative. They came up with a number of different solutions. Together we explored changing peril weights, territories that kind of thing, to shape the model loss solution to our in-force portfolio. As we through to the end of 2024, which has had a lot of SCS activity again, the model is basically working the way we expected it to work. We may not have a recovery this year, but that’s okay. The important thing is that the model is responding the way we expected it to respond. 

Matthew: John, one of the critical areas Peter has just mentioned is the role the broker has to play. What advice do you have for somebody who is a broker or agent who wants to understand how this works and wondering how they can help their clients understand the Demex offering? 

John: For the brokers, there’s a couple of things. First of all, regardless of what type of coverage the broker is going to offer, their client company is going to need good data, specifically good exposure data and good claims data. So I would recommend to any broker, get that data together now, for as far back as you can go, because it’s going to be invaluable to the process. 

The second thing I would say is to be very informed about how the product actually works and anticipate the questions that you’re going to get. From the ceding company, the most likely ones being: How do I recover on this product? How does it actually work so that I transfer risk and recover from it?

There’s a natural scepticism about new products that come into the marketplace. In the past some have come and gone quickly, but as Pete said, this one has a lot of advantages and a lot of potential staying power.

So ultimately, to be successful it’s incumbent upon the brokers to anticipate the questions that the cedants are going to have and be educated and prepared. 

Matthew: Yes, this is definitely not a solution looking for a problem. This is a problem that needs to find a solution. Matt, turning to you, how you can help people understand your solution, the retained climate risk reinsurance – or RCR Re – product you are offering from Demex? 

Matt Coleman: Yes, RCR Re was fundamentally created to reopen the reinsurance market for this aggregate protection. What that means is, that to address this problem of the accumulation of loss from frequent natural perils required a purpose-built solution. We offer five related areas of support:

First of all RCR Re is an holistic risk transfer solution where there is cedant calibrated models that is built individual or each cedant.

Secondly, we have a close partnership with reinsurance brokers to distribute that solution. 

The third area of support is that in addition to providing the insurance product Demex also acts as a calculation agent.

The fourth area of support is that we help to design and test the structures of the program so that these attach and exhaust to meet the risk management goals of the cedant. 

And finally, Demex has a reinsurance capacity network where we can match the underwriting guidelines and appetite of reinsurers to dozens of underwriting opportunities for individual cedents that seek this protection.

Matthew: Matt we’ve had a question from the audience that picks up on John’s comment about the need for good data. Does Demex support the complex commercial and industry portfolios that may have less SCS claims activity?

Matt: Yes it can, although this requires a slightly different approach, it’s more a treaty type solution. We see this as a frequency loss problem. And so that means we need a frequency modelling approach and therefore we need frequency data. 

And so typically this requires daily historic severe convective storms claims data and daily weather data. The analysis and the overlap of these data sets is what allows a more robust estimation of future frequent severe convective storm loss 

Pete: Demex also has some really good proprietary ways to mix actual claims data for a company along with industry level data. So for a young company like Branch, where we only had four years of track record, Demex was able to augment our real claims experience with industry experience customized to our type of portfolio that allowed, from a reinsurer’s perspective, good analysis to be done. With respect to small commercial lines I could certainly see an application. 

Matthew: Another question from our audience, if there is an alternative reinsurance solution, how does the cost of going with a parametric type solution compare to what a more traditional indemnity cover might look like?

John: I have found from the processes I went through for a couple of clients that these are very fair and vary depending on the kind of aggregate covers that we were placing in the years before the development of losses started to significantly escalate. Today, I think any buyer would look at the range of pricing that’s coming back on these new products such as Demex and find it quite reasonable.

Pete: When I you look at the cover that we’ve written in traditional reinsurance for a while, the Demex product that we wound up buying was similarly priced. So not materially different. 

Matt: And the main issue today is that our RCR Re offering brings aggregate protection to the market that typically is just not available. And when it is available. in those unique circumstances, the prices for that indemnity aggregate cover can now be very high. We’re seeing and transacting RCR Re transactions at a fraction of the cost of some of those traditional indemnity aggregate covers.

Matthew: So what’s going on if traditional reinsurance markets don’t want to cover SCS, but you’ve been able to go out and find capacity that is willing to support your new RCR Re solution? What’s shifting the mindset because I assume it’s similar reinsurance companies that are providing your capacity and they could otherwise have gone into the traditional market and offered it? Why is that? 

Matt: Yes, there is the higher strategic level motivation.  Fundamentally RCR re offers an alternative to the blunt decision to simply exit a market. If you are a reinsurer and you exit a market you’re missing out on growth and diversification opportunities. And so, by underwriting the RCR reinsurance solution, reinsurers again, have the ability to grow and diversify their books of business by accessing well packaged risk. This can be underwritten and priced on a risk adjusted basis with higher confidence at the product level, and because we use an index based design of the product.

It allows reinsurers to reduce loss cost uncertainty. And so reinsurers can still source the natural peril risk that they have always had appetite to underwrite but without the inflationary loss factors. These inflationary factors include things like inflated replacement costs, unexpected legal or regulatory issues and costs arising from the broader macroeconomic environment.

Matthew: John, is what Matt said consistent with what you’ve been hearing? 

John: Absolutely, Matthew. I agree with all the points that Matt made and buyers are also concerned about the transactional process. This includes issues such as: are we going to understand the model? Are we going to understand where the capacity has come from? How strong that capacity is? 

I’m sure Matt would agree that it took a couple of years for Demex to get things to where it is today, but all those boxes are checked now. It’s become a smooth transaction and one that buyers look at and say, “you know this reminds me of how my traditional program placements worked. When I shared the data, I got the model back. I got meaningful quotes with solid capacity behind them and the transaction can be consummated in a reasonable time” these are all important factors to the buyer, 

Pete: And to add from a reinsurer’s perspective, the two issues that any model loss solution addresses are firstly, the question of whether the insurer is charging an appropriate amount for the risk, both from a premium and a deductible standpoint. In a traditional coverage, reinsurers don’t know if the deductibles are being as widely used as it’s been represented to them as a reinsurer. And the second issue is the cedants’ properly valuing the risks. This is particularly important in a high inflation environment. And that is why a traditional indemnity solution can now rapidly change even over the course of a one year term contract.  Whereas in a model loss solution, that portfolio is fixed and the reinsurer doesn’t have to worry about the factors that might lead to an expectedly high ultimate net loss from an indemnity solution. The model loss solution takes these kind of risks off the table.

Matthew: Yes, we all know how important certainty. And what about total capacity? What is the extent of the total capacity that you can offer achieve at Demex with the companies you are working with?

Matt: We are operating in a reinsurance market that is used to relatively large transactions. The average deal size we see in terms of limit is around $25 million. And so that requires access to ample reinsurance capacity. Currently, we have access to over $300 million of reinsurance capacity in the aggregate. A subset of reinsurers in our risk capacity network have at appetite to write well over $50 million of limit for a single transaction.

To get to this point hasn’t happened overnight. It has taken time to explain our modelling approach, and it was very important for us to be very transparent in how our Modeled Loss Index is constructed. That transparency is highly valued by cedants and their reinsurance brokers, and also by reinsurers who effectively have the ability to recreate this Modeled Loss Index.  

We are being successful because we offer flexibility and the role that we can play as the calculation agent. We have a diverse pipeline of underwriting opportunities and we can match to a reinsurer’s specific appetite. Some reinsurers prefer to quote and lead firm order terms. Other reinsurers prefer to follow. Some prefer to underwrite smaller geographies with maybe a single state or a multi-state modelled loss index. Others prefer a more diversified national index for national cedents.  Some may prefer to transact larger lines of a smaller number of transactions.

This all reflects the ample demand for protection and the different types of cedants that need it. And then we have the sophistication of many reinsurers. They have a desire to grow strategically, but they also have the expertise and knowledge around parametric and other modelled loss solutions.

Matthew: Pete, on this point about communication and understanding, when you came across the Demex solution how did you convince your colleagues in Branch that this was the right thing to do?

Pete: For a small company like us, these decisions go all the way up to the board level. A model loss approach is something novel for most insurance board composition today. So what we did is we said, first of all, there is no indemnity solution in the market. So, if we can come up with a solution that approximates our portfolio relatively well, that something is better than nothing.

And then we said, here’s how our portfolio has responded in the past. And compare that to how this hypothetical model loss product would have responded in that same condition. People are concerned about basis risk, the difference between what the model says the losses will be and the difference between the actual incurred loss. We were confident that with Demex we had closed that gap sufficiently.

Matthew: John, anything you want to add to that from your experience? 

John: Pete stated it extremely well. Some companies have a decision-making framework where you have got to get to the CEO. I recommend in all cases that the chief actuary also be involved, the chief risk officer and others. What we’re seeing with Demex is that with more education and with more awareness about parametric solutions there are more discussions with people that are now more familiar with these concepts than there were back in 2022. 

Matthew: Matt, to that point of John’s, is what are you providing at Demex to help people understand this if they want to get into the details? 

Mat:: We take people through the different levels of understanding. At the outset, it’s largely a discussion either with a cedent, their broker or reinsurer – in each case we are asking “what is your risk management problem?”

Then we go a bit deeper.  “Do you have a frequency issue? Do you have a loss accumulation problem? What is the nature of your book of business?” 

And so first we begin discussing at a high level with the cedant. And then as we better understand the problem, we’re able to talk about the features of the RCR re solution.

Matthew: And what about educating the reinsurers?

On the reinsurer side, it often starts with talking about the underwriting opportunity. Some reinsurers, for example, may have a desire to come back down the risk tower, to write lower layers, in a calculated strategic way? 

These open question and answer discussions about what people are trying to achieve either as a reinsurance underwriter or in terms of buying protection allow us to then take the conversation to the next level. 

It’s very much an iterative process. We gather data. We analyze data, making sure that we understand what’s in those data sets and that we can use that for understanding severe convective storm losses in particular. 

Then we start building the model. We gather the universe of weather data and weather variables and overlay those with cedant specific exposures and cedant specific claims history. From this we can start to quantify the relationship between weather and loss.

And we may go to an even deeper level when we continue to iterate with, for example, a chief actuary in their data science team or a chief underwriter at a reinsurer in their analytical team. 

They want to understand not just how the product works, but want answers to questions such as: how will it settle? What will the process be for settlement? What is the timing operationally from a transaction perspective? What do wordings look like again? Does this look and feel like a traditional indemnity aggregate cover that I can understand and which I can transact? Ultimately, we want to ensure they all understand the overarching value proposition of RCR Re in the context of what the product ultimately costs. 

Matthew: Another question from our audience, is Demex offering a solution outside of the US, in Europe or Australia, for example? 

Matt: Yes we are. The approach that we take works globally, weather data is available globally. We can match and overlay that data with the cedant specific data and claims and exposures. Currently we’re focused on the United States because there is such large amount of demand for protection and a solution but we have our eye on places like continental Europe, including Germany and Italy, as well as Australia and East Asia. And of course, the idea of gathering weather data and this overall modelling approach applies to other frequency perils, too, like winter storm, heat or freeze issues, excess rainfall and drought. There’s a lot of opportunity to continue growing the application of the solution. 

Matthew:  As we come towards the end, I want to give each of you a chance to leave us with what you feel is the important thing to be aware about this topic.

John: The problem isn’t going away. It’s unlikely that in the short term that the simple indemnity solutions that insurers have been most familiar with in the past as buyers are going to reemerge. It’s time to look at alternative solutions. This offering from Demex extremely well thought out. For some people, I say, yes, it may require overcoming your initial trepidation, but I recommend taking time to understand how the modelling works and how recoveries are generated and then moving forward.

Pete: One of the most common board level questions with solutions like this is a misconception that a parametric solution isn’t going to work for their company’s specific portfolio. But what is really important here that in this modelled loss solution, the portfolio that is created is tailored to your actual in-force portfolio. It’s important to distinguish a customized model loss solution like this versus a standard parametric “cat-in-a-box” kind of solution”. 

Matt: It’s crystal clear now that severe convective storms are the single largest insured loss problem in the property insurance industry today. And the Retained Climate Risk reinsurance product that Demex offers is unique. It’s innovative and ultimately, it’s packaging risk in a way that gives the protection that insurance buyers need/ It brings reinsurance capacity providers back to the table, offering that protection at prices that cedents can afford. 

Matthew: And how can people learn more about Demex and the RCR Re product. 

Matt: Due to our current traction and awareness in the market that already exists, cedents can begin by contacting their reinsurance broker. to learn more about the product. We have relationships with all of the major global reinsurance brokers.

In addition, contact Demex directly through our website or through LinkedIn. And we can then direct any product related, modelling related or capacity related questions to the relevant team within our company.