After fearing the worst from Hurricane Milton, investors in catastrophe bonds appear to have sustained losses well below those predicted as recently as Wednesday.
Estimates that had indicated the bonds would lose as much as 15% have now been replaced by calculations showing investors are more likely to see a hit in the single digits. That’s after Milton made landfall as a Category 3 hurricane, weaker than originally forecast.
“Tampa was spared from the feared scenario of a direct hit,” Icosa Investments AG said in a statement on Thursday. “Thanks to strong wind shear and a more southerly track than expected, Tampa was less affected than it would have been if the storm had tracked slightly further north.”
Overall, Icosa now sees insured losses in the range of $20 billion to $60 billion, meaning cat-bond investors look to be facing a maximum hit of 4%. On Wednesday, before Milton landed, Icosa warned that a direct hit to Tampa threatened to cause insured losses anywhere from $40 billion to $150 billion, resulting in cat-bond losses of 2% to 15%.
While the dent to cat-bond portfolios is likely to be smaller than first indicated, the development still marks a meaningful shift from 2023, when the securities soared a record 20%, according to the Swiss Re cat-bond index. In 2022, investors swallowed a 2% decline as the market absorbed the impact of Hurricane Ian.
Milton, which is estimated to have knocked out power for more than 3 million homes and businesses in Florida, came ashore south of where Hurricane Helene struck two weeks ago. The US mainland has been hit by five hurricanes so far this year, including Beryl, which battered Houston in July and knocked out power to millions of homes and businesses.
Catastrophe bonds, or cat bonds as they’re known in the industry, are issued by insurers and reinsurers to provide financial protection against the most severe natural disasters.
Investors who buy the bonds stand to make large gains if a predefined event doesn’t occur, but can lose a big chunk of their capital if it does. Those losses are used to cover insurance claims. Most of the $48 billion cat-bond market is focused on US storms, with the lion’s share of that centered on Florida.
Cat bonds have so far been spared a major trigger event this season, thanks to carefully calibrated terms that mean investors are only called on to pay out if specific, predefined conditions are met. What’s more, determining whether bondholders will be asked to provide coverage may take months, with uncertainty generally favoring investors. And in the past, some investors have even used that uncertainty to engage in costly lawsuits, rather than pay out.
The ability of cat-bond modelers to protect against losses was on full display after Hurricane Beryl ripped through Jamaica in July, prompting the government to declare the entire island a disaster area. The fact that such devastation wasn’t enough to trigger Jamaica’s cat bond has led to calls for a review to determine whether the securities are fit for purpose.
Icosa said it’s currently expecting losses in its portfolios won’t exceed low single digits. If that scenario pans out — assuming there are no further hits to the portfolio and with current cat bond yields above 10% — Icosa reckons the cat bond market could still deliver a “significantly positive return” for 2024.
And if industrywide losses settle at the lower end of the expected range, it’s even possible that there’ll be no losses at all, Icosa said. “However, since the fund is valued based on bid prices, we expect short-term markdowns, which are likely to normalize in the coming weeks.”
Twelve Capital AG, which has a $3.8 billion cat-bond portfolio, had also initially estimated losses as high as 15%. It, too, is now scaling back those predictions.
“Cautiously, we’d say it’s likely less,” Tanja Wrosch, head of cat-bond portfolio management, said in an interview Thursday on Bloomberg TV. “It played out in the end a little bit better.”
Deciding which cat bonds pay out and by how much isn’t always straightforward because it requires identifying the source of the damage.
For most storm-related bonds, “you only have the wind policies covered, so the flood shouldn’t theoretically be covered,” Wrosch said. But for major hurricanes like Milton, “it’s very hard to tell in the aftermath from where the damages came: Was it flood or was it wind?” Sometimes investors will have to cover some flood and storm-surge losses, she said.
The insurance industry also appears to have avoided debilitating losses.
“Hurricane Milton’s weakening to a Category 3 storm before making landfall likely means the insurance industry and reinsurers such as Munich Re and Swiss Re may escape a worst-case scenario of more than $100 billion of losses,” according to analysts at Bloomberg Intelligence. Lower wind intensity suggests insured losses may instead be $35 billion to $45 billion, BI said.
That said, cat-bond risk premiums remain high as uncertainty persists. And the prospect of losses from Milton and damage from other potential hurricanes this season mean that investors are seeking — and getting — a considerable return for taking on natural disaster risk.
“Given the significant losses for the reinsurance industry, premiums are expected to remain at current high levels or even increase further in the coming weeks,” Icosa said. “This presents an attractive opportunity for investors to enter the cat bond market.”
Photo: A boat is washed ashore following Hurricane Milton’s landfall in Punta Gorda, Florida, on Oct. 10. Photographer: Joe Raedle/Getty Images
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