Disaster bond investors brace for big losses as Milton rages

(Bloomberg) — Catastrophe bond investors are bracing for big losses as the combined destructive force of Hurricanes Helen and Milton looks set to trigger payment terms on a scale not seen in years.

Most read from Bloomberg

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

Milton hitting the Tampa metropolitan area with even a weaker Category 4 hurricane “could result in one of the largest reinsurance loss events in history,” Florian Steiger, founder and CEO of Icosa Investments AG, said in an interview.

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

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

“One of the big elements in Milton will be storm surges and flooding from the ocean,” she said.

Catastrophe bonds, or cat bonds as they are known in the industry, are issued by insurance and reinsurance companies to provide financial protection against more serious natural disasters. Investors who buy bonds could make significant gains if a predetermined event does not occur, but could lose a significant portion of their capital if it does. These losses are used to cover insurance claims.

Potential losses on Milton & Helen’s surety bonds would mark a stark reversal for a debt market that last year fueled the most profitable hedge fund strategy, according to an analysis provided by Preqin. The Swiss Re Global Cat Bond Index is up 20% in 2023, outpacing returns across other major debt markets.

The story continues

In 2022, IAN caused insured losses of approximately $60 billion. Milton could cause damage and losses ranging from $60 billion to $75 billion, with some models showing the total as high as $150 billion, Chuck Watson, a disaster modeler at Enkei Research, said in a post on X.

The amount investors will be required to pay to cover the Milton effect depends on the extent of the damage. Florida Citizens, the state’s insurer of last resort, is expected to raise about $500 million from one of its cat bonds, according to a person familiar with the issuance.

Cat Cat bond investors may also be harmed by inland flooding caused by Hurricane Helen. Moody’s RMS estimates that insured losses in the US private market from Helen will range from $8 billion to $14 billion.

“Helen was a once-in-a-thousand-year event,” said Jonathan Schneier, director of disaster response at CoreLogic Inc., a disaster modeling firm in Irvine, California. “It shows the strength of the hurricane inside.”

Investors are also exposed to flood-related losses from Helen through their holdings of FEMA cat bonds. In an email response to questions, FEMA said it had transferred $1.9 billion in flood risk to the private sector ahead of the 2024 hurricane season, with most of that amount landing in the CAT bond market.

FEMA said it was “too early to make any predictions” about the extent to which these bonds would be activated. As with other indemnity-style hurricane bonds, the calculation is based on actual losses incurred on the ground, which can take a long time to calculate.

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

Investors in the $60 billion private market for insurance-linked securities may face greater risk of losses than holders of CAT bonds, because insurance-linked check products have lower trigger thresholds.

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

Frosch said there is currently a lot of “noise” in the cat bond market. “There were some deals that fell through.”

(Updates second paragraph with Milton restored to Class 5 power)

Most read from Bloomberg Businessweek

©2024 Bloomberg L.P