Catastrophe bond issuance just hit record levels as the market prepares for a severe hurricane season that could cause significant damage.
Sales of so-called cat bonds this year through May are 38% higher than during the same five-month period in 2023, already a record, according to Artemis, a compiler of data on insurance-related securities. Moreover, the $4 billion issued in May alone represents the largest volume of catastrophe bonds ever sold in a single month, Artemis said.
The event looks set to reshape the market, which last year supported the world’s best-performing hedge fund strategy. Cat bonds, which allow insurers to transfer risks to capital markets, can leave an investor with huge losses in the event of a catastrophe and huge profits otherwise. Cat bonds are up 20% in 2023, marking the best annual return in nearly its history. three-decade history.
Now, some savvy catastrophe bond investors are looking for ways to reduce their exposure as forecasts point to a particularly active hurricane season.
Tenax Capital, an asset manager specializing in cat bonds, says it needs to take a closer look at situations where various forecasting agencies are predicting a more active hurricane season than normal, which is then reflected in daily portfolio decisions.
In the firing line are bonds that are among the worst performers when extreme weather events occur, says Toby Pugh, an analyst at London-based Tenax. The fund manager is now “even more strict about what we buy” and limits investments in cat bonds that are triggered by statistically rare and large events, he said.
Extreme weather events are among a number of factors affecting the issuance of cat bonds. Others include inflation and population density. All of these parameters have increased in recent years, leading insurers and reinsurers to rely more heavily on capital markets to cover potential losses.
Bond issuance, including non-property and private transactions, reached a record level of more than $16 billion in 2023. Artemis estimates that the current value of outstanding cat bonds is $49 billion. It’s important to note that there were relatively few weather events last year that ultimately triggered cat bond provisions, making investors extremely wealthy.
This year the risks seem higher.
Thanks to near record ocean temperatures and the transition to La Niña conditions, the US is expected to have an extremely active hurricane season. Scientists from Colorado State University predict 23 named storms, 11 hurricanes and five major hurricanes, well above the historical average. They also warn of a higher likelihood that at least one major hurricane will make landfall this year.
No one can accurately predict the size and direction of a Caribbean storm. But a series of accumulating risks—climate change, increased real estate vulnerability and inflation—have increased the financial impact of any hurricane season, especially a more active one.
“The U.S. avoided a truly catastrophic hurricane season last year, but if forecasters are right, we may not be so lucky in 2024,” he said. Adam Kamins, economist at Moody’s Analytics, a division of Moody’s. “With little sign of a slowdown in construction in high-risk coastal areas, a severe storm will have significant impacts.”
Prospects for Florida, where she became it’s getting harder Gaining access to insurance is now prompting cat bond investors to approach some segments of the market with caution.
“I wouldn’t be surprised if some investors say they don’t intend to issue Florida bonds this year,” said James Eck, senior credit officer at Moody’s.
Given the growing risk associated with owning securities, investors are now demanding higher returns from issuers. Artemis notes that cat bond spreads rose 23% between March and the end of May.
Meanwhile, insurers and reinsurers continue to transfer a significant portion of their tail disaster risk to the capital markets. Notable issuers include Citizens property insurance company.Florida’s property insurer of last resort, which recently completed $1.1 billion in cat bonds ahead of the hurricane season. Texas Storm Insurance Association recently sponsored a $1.4 billion cat bond issue, the largest ever.
Countries exposed to the risk of extreme weather also use the cat bond market. In April, the World Bank issued three cat bonds that provide $420 million in insurance coverage for Mexico against hurricanes and earthquakes. A week later, the bank priced a $150 million catastrophe bond for Jamaica against said hurricanes. The deals are part of the World Bank’s goal to increase up to $5 billion in bonds outstanding over the next few years.
Of course, a more active hurricane season doesn’t always mean bigger cat bond losses.
“It all depends on where the hurricane makes landfall,” said Charles Graham, an insurance analyst at Bloomberg Intelligence. A hurricane in a sparsely populated rural area might cause little damage, “but if something came right through Miami, it would be a different story,” he said.
History shows that “large losses do not necessarily have to be caused by a strong season,” according to a recent report from Man’s AHL division Man Group Plcthe world’s largest publicly traded hedge fund manager.
However, climate change is increasingly becoming a wild card for cat bond investors. Moody’s notes that 17 of the 19 costliest hurricanes in the U.S. occurred in the last 20 years, even when adjusted for inflation. Added to this is the dramatic increase in the frequency of billion-dollar events.
Costly storms threaten to “destabilize” the insurance market as some insurers flee high-risk areas such as Florida and California, according to Moody’s.