Catastrophe bond investors brace for major losses as Milton rages

Catastrophe bond investors are bracing for substantial losses as the combined destructive force of Hurricanes Helene and Milton looks set to trigger defaults on a scale not seen in years.

Two weeks after Helene triggered severe flooding in more than a dozen states, Florida is bracing for the impact of Milton, which regained Category 5 strength on the five-step Saffir-Simpson scale. It is expected to make landfall early Thursday morning, pushing a wall of water ashore. Millions of people have already fled the coastline, including residents of the densely populated city of Tampa.

Even if Milton hits the Tampa metro area as a weaker Category 4 hurricane, “it could result in one of the largest reinsurance loss events in history,” Florian Steiger, founder and chief executive of Icosa Investments AG, said in – an interview.

Read more: Hurricane Milton is about to end Tampa’s century of good luck

Such a scenario would have the potential to exceed the effects of Hurricane Ian in 2022, according to Steiger. Ian’s impact led to a 10% drop in the Swiss Re Catastrophe Bond Index in September 2022, sending shockwaves through catastrophe bond portfolios and fueling an issuance boom as insurers shifted more risk from their books to capital markets.

Tanja Wrosch, head of cat-bond portfolio management at Twelve Capital AG, says if Milton hits Tampa head-on as a major hurricane, the catastrophic losses “will be more significant than Ian.” The Swiss asset manager has a $5 billion portfolio, including $3.8 billion of catastrophe bonds.

“A big component from Milton is going to be storm surge — flooding from the ocean,” she said.

Catastrophe bonds, or cat bonds as they are known in the industry, are issued by insurers and reinsurers to provide financial protection against the worst natural disasters. Investors who buy bonds can make big gains if a predefined event doesn’t happen, but they can lose a lot of their capital if it does. These losses are used to cover insurance claims.

Potential cat bond losses from Milton and Helene would mark a sharp turnaround for a debt market that last year underpinned the most profitable hedge fund strategy, according to an analysis by Preqin. The Swiss Re Global Cat Bond Index rose 20% in 2023, undercutting yields in other key debt markets.

In 2022, Ian caused about $60 billion in insured losses. Milton could cause $60 billion to $75 billion in damage and losses, with some models putting the total as high as $150 billion, Chuck Watson, a disaster modeler at Enki Research, said in a post X .

How much bond investors will be required to pay to cover Milton’s impact depends on the extent of the damage. Florida Citizens, the state’s insurer of last resort, will collect about $500 million from one of its cat bonds, according to a person familiar with the matter.

Cat-bond investors could also be affected by inland flooding from Hurricane Helene. Moody’s RMS estimates US private market insured losses from Helene to be $8 billion to $14 billion.

“Helene was a one-in-a-thousand year rainfall event,” said Jonathan Schneyer, director of disaster response at CoreLogic Inc., a disaster modeling firm in Irvine, California. “It shows the power of a hurricane further inland.”

Talk of a trigger event in the wake of Helene and Milton comes after cat-bond investors managed to avoid losses linked to Hurricane Beryl. Even though Jamaica was declared a disaster area after Beryl ripped through the Caribbean island three months ago, the catastrophic bond issued to protect the government has not been triggered. This has led to calls for an overhaul of Jamaica’s catastrophe insurance framework amid a wider discussion among a group of Caribbean nations calling for “a review” of cat bonds and other insurance-related securities.

The securities are for “end events,” Michael Bennett, head of derivatives and structured finance at the World Bank’s treasury, which helped arrange Jamaica’s bond, said in August.

In Jamaica’s case, Beryl fell well short of hitting the benchmark that would have caused the bond to default, Robert Muir-Wood, director of insurance solutions research at Moody’s, said at the time. “It was a very close call.”

This time, however, cat bondholders appear to be facing a whole series of trigger events. Investors are exposed to losses related to the Helene floods through their holdings of cat bonds issued by the Federal Emergency Management Agency. In an emailed response to questions, FEMA said it had transferred $1.9 billion of flood risk to the private sector ahead of the 2024 hurricane season, the bulk of which landed in the kitty bond market .

FEMA said it is “too early to make predictions” about the extent to which those bonds will be triggered. As with other indemnity hurricane bonds, the calculation depends on actual losses on the ground, which can take a long time to calculate.

“Typically you have an initial estimate in a few weeks, but the speed of payment is typically months to years,” depending on the complexity of the loss, said Rhodri Morris, head of insurance-related securities analysis at Twelve Capital.

Investors in the $60 billion private market for insurance-linked securities may face an even greater risk of loss than cat bondholders because ILS products have lower trigger thresholds.

Meanwhile, there are signs that some cat bond traders are starting to lose their tempers. On Monday, someone dumped a Florida cat bond for just 67 cents on the dollar, according to Twelve Capital.

There’s a lot of “noise” in the cat bond market right now, Wrosch said. “There were some distressed deals.”

Although investors are in for a turbulent time, the cat bond market has a history of rebounding. After Hurricane Ian triggered losses, investors began demanding significantly higher premiums to take on such risks. This development contributed to record returns a year later, according to the Swiss Re index.

“Of course any loss hurts,” Icosa’s Steiger said. “But prices will skyrocket, and the trajectory of expected future returns could outweigh the short-term loss.”

Photo: Piles of debris from Hurricane Helene remain uncollected ahead of Hurricane Milton’s expected landfall in Treasure Island, Florida, U.S., Monday, Oct. 7, 2024. Milton became a catastrophic Category 5 hurricane as it approaches the West Coast of Florida, where residents began fleeing inland in a region still recovering from Helene’s devastation.

Copyright 2024 Bloomberg.

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Loss of profit in catastrophe