‘Cat bonds’ may turn into dogs for in­vestors

Financial Chronicle - - MONEY & MARKETS - BENOIT TOUSSAINT

IN­VESTORS in "cat bonds"—or catas­tro­phe bonds—may find them­selves in fi­nan­cial straits af­ter in­sur­ers tot up their losses from hur­ri­canes Har­vey and Irma and put the nascent al­ter­na­tive rein­sur­ance mar­ket to the test.

In re­cent years, cat bonds have en­joyed in­cred­i­ble growth in the United States as in­sur­ers seek a more af­ford­able op­tion than tak­ing out a con­tract with tra­di­tional rein­sur­ers.

Much like with a tra­di­tional bond, in­vestors hand over a sum of money to ob­tain a cat bond, and are paid in­ter­est. They have been at­trac­tive to in­vestors in the cur­rent low-rate en­vi­ron­ment as they of­ten of­fer higher in­ter­est.

The catch is that if the nat­u­ral dis­as­ter spec­i­fied in the bond takes place the in­surer may not pay back part or all of the bond and use the funds to cover its losses or re­plen­ish its cap­i­tal.

How­ever, with­out a ma­jor hur­ri­cane in re­cent years, in­vestors have been snap­ping up cat bonds.

In 2016, the al­ter­na­tive rein­sur­ance mar­ket was worth $81 bil­lion, af­ter ex­pand­ing by nearly 13 per cent for two straight years, ac­cord­ing to data from Bri­tish rein­sur­ance bro­ker Aon Ben­field.

That put it at just un­der 14 per cent of the size of the tra­di­tional rein­sur­ance mar­ket.

But the favourable winds may be over.

"Har­vey and Irma are sig­nif­i­cant events for the sec­tor... They will be a test for al­ter­na­tive cap­i­tal," said Torsten Je­wor­rek, a mem­ber of the man­age­ment board at Ger­man rein­sur­ance gi­ant Mu­nich Re, at an in­dus­try con­fer­ence in Monaco this week.

Je­wor­rek also es­ti­mated Har­vey, which lashed Texas and Louisiana with un­prece­dented rain last month, could end up cost­ing in­sur­ers be­tween $25 and $30 bil­lion.

Dam­age es­ti­mates for Hur­ri­cane Har­vey, which made land­fall in Texas on Au­gust 26 be­fore re­turn­ing out to sea to then lash Louisiana, vary from around $50 bil­lion to well in ex­cess of $100 bil­lion.

How­ever, not all prop­erty was in­sured or fully in­sured.

Nev­er­the­less, with Har­vey and Irma, cer­tain "cat bonds will be trig­gered, the ex­pected prof­itabil­ity won't be there and there may even be losses," said Claude Tendil, the or­gan­iser of the an­nual in­sur­ance con­fer­ence known as Septem­ber Ren­dezvous.

"The al­ter­na­tive fi­nance mar­ket could ex­pe­ri­ence a sud­den stop," he added.

Be­fore Hur­ri­cane Irma struck Florida, rat­ings agency S&P Global Rat­ings iden­ti­fied 13 cat bonds that could get trig­gered, de­pend­ing on its path and the sever­ity of dam­age.

"Ever since the first catas­tro­phe bond was is­sued, the ques­tion 'How would the mar­ket re­act to a ma­jor event?' has loomed, and Hur­ri­cane Irma could very well be that event," the agency wrote in a re­cent re­port.

Some bonds could pos­si­bly see a loss on the in­vest­ment prin­ci­pal, but S&P Global Rat­ings re­mained san­guine about the prospects for the cat bond mar­ket, even if some in­vestors get burned by Irma.

"As to what hap­pens postIrma, even if bonds were to suf­fer prin­ci­pal re­duc­tions, we ex­pect most in­vestors would re­main, as pe­ri­odic losses are to be ex­pected. So, one event, even a ma­jor one, should not re­sult in a mass ex­o­dus," said the agency.

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