Catastrophe Bonds Suffer Biggest Crash In History
Lat week, when the eye of Hurricane Irma was still expected to pass over Miami, resulting in potentially unprecedented damages, including dramatic losses to the P&C sector, we reported that “Catastrophe Bond Investors Face Wipe Out As Hurricane Irma Approaches.” This was partially validated by several liquidation trades, the most prominent of which was the plunge in the Citrus Re Cat bonds, which were repriced from par to 50 cents on the dollar after someone dumped a massive chunk of the paper heading into this weekend, unwilling to hold on further risk exposure which according to some of the more aggressive loss estimates, saw as much as the entire principal on the issue wiped out.
As it turns out, it wasn’t just that one Citrus Re seller who got spooked: following the latest weekly remarking of the Swiss Re Cat Bond price return Index, the entire catastrophe bond sector saw broad-based, pardon the pun, liquidations last week and as a result was marked down by a record 16% on Friday, wiping out all of the year’s gains and then some.
And yet, despite concerns of a worst-case scenario, hurricane Irma weakened as it moved past Tampa on Monday, leaving in its wake a state that avoided the worst predictions of its destruction by sea and storm.
“Miami and Miami Beach, we didn’t dodge a bullet, we dodged a cannon,” Miami Beach Mayor Philip Levine said in an interview Monday morning.
So in light of the sharp reduction in estimated damages from Irma, investors are assessing whether the record plunge in cat bonds is justified and if it makes sense to, well, BTFD.
As reported earlier, various analysts have released revised damage numbers on Monday, prompting a sharp squeeze in P&C stocks. As Bloomberg reported, Chuck Watson, an Enki Research disaster modeler in Savannah, Georgia, had predicted total damages as high as $200 billion. However, the hurricane dwindled to a Category 2 before reaching the Tampa Bay area. That could keep damages under $49 billion, with insured losses at about $19 billion, sparing insurance companies, Watson said. Bloomberg Intelligence analyst Jonathan Adams puts insured losses now at $13 billion, down from an earlier estimate of $33 billion.
Citi, similarly, reduced its Irma-related losses from $150 billion to only $50 billion; AIR Worldwide lowered its top estimate for U.S. insured damage from Hurricane Irma to $40 billion from $50 billion, maintaining the low end its expected range at $20 billion, according to Artemis.
By comparison, total losses from Hurricane Katrina reached $160 billion in 2017 dollars after it slammed into New Orleans in 2005. While Irma didn’t reach that level of destruction, it could surpass the damage caused by 1992’s Hurricane Andrew that punched its way across the Florida peninsula.
Furthermore, as Gadfly notes, on Saturday, risk modeling company RMS said there’s only a 10% chance that wind losses from Irma will exceed $60 billion, an estimate that will be drastically lowered further this week. That should give a further boost to the cat bond market, as 60% of it is linked to wind damages.
The weighting toward wind makes sense, as it’s much easier to model. Flood is a different matter — it’s much harder to project losses, and so comprises a much smaller part of the catastrophe bond market, which itself occupies one corner of the reinsurance sector known as the insurance-linked strategies market.
And while flood-related losses will likely be sizable, worries here are more constrained as they are more broadly diluted across the entire Insurnance-Linked Securities space:
“instruments linked to flood risk are dispersed across the ILS market, and a wobble in one of them need not affect the whole sector. As concern begins to shift from the initial storm hit to the damage from rising water levels, it looks like both the ILS and cat bond markets will be able to cope with the damage, and the rest of the U.S. storm season.”
And so, following a restless weekend in which the smallest of revisions in the hurricane’s path resulted in dramatic downstream consequences for billions in assets, investors are offered yet another opportunity to generate short term returns, this time courtesy of Buying The Hurricane Dip.