Catastrophe bond investors brace for big losses as Milton rages

(Bloomberg) — Investors in catastrophe bonds are bracing themselves for substantial losses as the combined destructive power of Hurricanes Helen and Milton will trigger payment clauses on a scale not seen in years.

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Two weeks after Helen caused devastating flooding in more than a dozen states, Florida is bracing itself for the effects of Milton, which on Tuesday regained Category 5 strength on the five-step Saffir-Simpson scale. It is expected to push a wall of water ashore and make landfall on Thursday morning. Millions of people have already fled the coast, including residents of the densely populated city of Tampa.

Even as a weak Category 4 hurricane hitting the Tampa metropolitan area was “the largest reinsurance loss in history,” Florian Steiger, founder and chief executive of Ecosa Investments AG, said in an interview. May be one of the events.”

Such a scenario would have the potential to exceed the landfall of Hurricane Ian in 2022, according to Steiger. Yan's impact led to an initial 10% decline in the Swiss Re catastrophe bond index in September 2022, sending shockwaves through catastrophe-bond portfolios and feeding an issuance boom as insurers shifted more of the risk on their books to capital markets.

Tanja Rosch, head of cat-bond portfolio management at Twelve Capital AG, said if Milton were to hit Tampa as a major hurricane, the catastrophe-bond losses “would be more significant than the ion.” The Swiss asset manager has a $5 billion portfolio, including $3.8 billion in catastrophe bonds.

“A big component of Milton will be storm surge — flooding from the ocean,” he 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 most severe natural disasters. Investors who buy bonds stand to make large gains if the predetermined event does not occur, but stand to lose a large portion of their capital if it does. These losses are used to cover insurance claims.

Potential cat-bond losses from Milton and Helen would mark a stark change for a debt market that underpinned the most profitable hedge fund strategies last year, according to an analysis by Prekin. The Swiss Re Global Cat Bond Index rose 20% in 2023, outperforming returns across other key debt markets.

In 2022, Yan caused approximately $60 billion in insured losses. Milton could cause $60 billion to $75 billion in damages and losses, with some models reaching a total of $150 billion, Chuck Watson, a disaster modeler at Enki Research, said in an X Post.

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

Cat-bond investors may also be hit by inland flooding caused by Hurricane Helen. Moody's RMS estimates that U.S. private-market insured losses from Helen will be $8 billion to $14 billion.

“Hellen was a thousand-year rainfall event,” said Jonathan Schneier, director of disaster response at CoreLogic Inc., a disaster-modeling firm in Irvine, California. “It shows the strength of more inland hurricanes.”

Investors covered losses from Helen's flooding through cat bonds issued by the Federal Emergency Management Agency. In an emailed response to questions, FEMA said it has transferred $1.9 billion in flood risk to the private sector ahead of the 2024 hurricane season, with most of it landing in the cat-bond market.

FEMA said it was “too early to make any assumptions” about how much those bonds would trigger. As with other indemnity-style hurricane bonds, the calculation depends on actual damage to the ground, which can take a long time to calculate.

“Typically, you have an initial estimate in a few weeks, but the payout speed is usually months to years,” says Rhodri Morris, head of insurance-linked securities analytics at Twelve Capital, depending on the complexity of the loss.

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

There are signs that some cat-bond traders are starting to lose their nerve. 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, Rush said. “There have been some upset trades.”

(Milton updates second paragraph with restoring Category 5 energy)

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