As hurricane season approaches, cat bond market shows its appetite

The catastrophe bond market continues to show its appetite to take on peak peril risks such as U.S., and especially Florida, tropical storm and hurricane risks, with over $4.1 billion of 2014 cat bond issuance having some exposure to hurricane season.

The 2014 Atlantic tropical storm and hurricane season is set to officially begin on the 1st of June, the start of a long season that runs to the end of November. As a peril or risk that is assumed by global reinsurers and the insurance linked securities market, hurricane risk remains the number one threat to reinsurer, and ILS manager, profitability and the largest single exposure for most players in these markets.

In 2014 the catastrophe bond market and insurance linked investors have shown their continued appetite for U.S. hurricane risk, with just over $4.15 billion of the catastrophe bond issuance recorded in the Artemis Deal Directory containing exposure to U.S. tropical storms and hurricanes.

That is almost 76% of the all the catastrophe exposed risk capital issued in 2014, excluding the Vitality health-linked ILS deal, which is a high percentage for the market, underscoring its appetite to be the leading source of risk capital for this peak peril. Approximately 62% of 2014 catastrophe bond issuance to date has some exposure to Florida tropical storms and hurricanes, showing the States reliance on risk capital.

Interestingly the exposure to the U.S. hurricane season is perhaps greater now for the catastrophe bond market than it was in previous years. The majority of cat bonds exposed to hurricanes are actually covering U.S. named storms, so this is any storm which is named by the National Hurricane Centre during the season. That means any tropical storm, whether ever it becomes a hurricane, or perhaps weakens after having been a hurricane, still holds an exposure for catastrophe bond investors.

In the past many hurricane cat bonds were only exposed to a storm which was officially a category 1 or stronger storm. As the ILS market has sought to become more comparable with traditional reinsurance, so offering a greater level of cover to cedents, this adjustment was made and so the market is now exposed to much weaker storms.

However, just because a tropical storm has winds under hurricane strength doesn’t mean it couldn’t become a threat to any exposed catastrophe bonds. Tropical storms can have a habit of maintaining strength as they travel inland, extending the region that is impacted and causing more damage and losses. Equally rainfall, tornadoes, hail, storm surge and other effects of tropical storms can all cause losses sufficient to worry some of the cat bonds in the market right now.

Sponsors of cat bonds have taken advantage of this adjustment to the peril description for U.S. wind and have also chosen to issue more aggregate bonds to cover themselves against multiple, weaker but still impactful storms. This is a trend we are likely to see continue, at least as long as pricing remains at the current low levels.

Hurricane forecasts for the 2014 season remain below normal, with the likely development of El Nino conditions cited as a factor which will result in less storms forming. However, the risks of landfall remain about normal and some forecasters are stressing that even in El Nino years we have seen some of the most devastating hurricanes on record, so the 2014 season is no time to be complacent.

In fact, on the 1st of June when the hurricane season begins it will have been 3,142 days since a category 3 or stronger hurricane made landfall on the U.S. coastline, a record by a fair margin according to Roger Pielke Jr. The previous longest gap between Cat 3+ hurricane landfalls is almost 1,000 days shorter, showing how unusual this quiet spell has been and that the U.S. is overdue a major hurricane impact.

Whether that will happen in 2014 is impossible to forecast, but some experts suggest that storm formation may be unusual this year with more intense storms forming closer to the U.S. due to warmer northern Atlantic waters. So 2014 is definitely a year to keep a weather eye on the tropics as the season progresses.

Of course the reinsurance industry and the ILS space remains extremely well-capitalised and able to cope with most hurricane and tropical storm impacts. It will take a massive event, creating $100 billion+ in industry losses to really turn the needle at this time and even then it may need an element of the unexpected about the resultant loss to really create an environment to push rates back up.

Ratings agency Fitch said today about the insurance sector and the hurricane season; “Fitch estimates that given the current substantial level of industry capitalization, it would likely take a record individual storm loss or a series of significant losses equal to 15% or more of industry aggregate surplus for consideration of a property/casualty sector outlook movement to negative tied to catastrophe experience.”

“From the perspective of the insurance industry, the intensity and location of storms making landfall are the most critical variables,” says Christopher Grimes, Director at Fitch Ratings. “While fewer and less severe storms bode well for the industry, the property/casualty segment remains positioned to withstand the impact of future significant events.”

Fitch notes that the process for insuring and reinsuring higher catastrophe exposed areas, such as Florida for hurricane risks, is evolving as insurers of high-risk zone properties expand their use of alternative reinsurance capital, catastrophe bonds and ILS. This trend is set to continue as the ILS market remains an efficient form of lower-cost risk capital with a strong appetite to grow and these peak zones being the ideal growth area for cat bonds and ILS.

Insurers such as Florida’s Citizens Property Insurance Corp. are benefiting greatly from the ILS markets appetite and ability to assume hurricane risks, with its record $1.5 billion Everglades Re Ltd. (Series 2014-1) a clear demonstration of the ability of efficient capital to absorb these peril exposures.

Reinsurance buyers in Florida and other hurricane exposed states have also benefited greatly from the appetite for insurance linked investments, which has made catastrophe bonds and collateralized reinsurance increasingly available and competitive with traditional reinsurance covers.

Of course traditional reinsurers have also played their role in making this perhaps one of the best protected against hurricane seasons on record, as they relaxed terms and conditions to compete with the highly capitalised traditional reinsurance market and the appetite of alternative capital.

That relaxation of terms could come back to bite some reinsurers in 2014, with and impacts and losses during hurricane season likely to show up any slipping of underwriting discipline in the market.

ILS and alternative capital providers stand ready to fill any gaps created by reinsurers which feel the need to scale back providing coverage in some peak hurricane zones. This is the sweet spot for ILS, where the collateralized nature, efficiency and lower-cost of the capital backing transactions has an advantage over equity backed reinsurers, at least to a degree.

As ILS investors continue to become increasingly sophisticated and gain better understandings of the risks posed by perils such as hurricanes, we can expect the focus on this peril and region to continue in the catastrophe bond market. While some say the cat bond market is overexposed to U.S. hurricanes, others say that is exactly what it was created for, to absorb the peak perils allowing traditional reinsurance capital to focus where it is most efficient.

Of course we have yet to see a major hurricane season impact to the catastrophe bond market, so we cannot predict exactly how it might react to a number of cat bonds all facing losses at once. Anecdotally, investors we speak with say they are prepared to face losses and enter into this market with eyes wide open and in expectation that they will lose their capital at some point in time.

Every year the catastrophe bond market wonders whether this will be the year that hurricane season deals it a severe blow, but to date we have yet to see that play out. 2014 could be the year and with cat bond issuance to date this year being once again dominated by hurricane risk the market will need to keep its eye on the seasons development, no matter how well capitalised ILS and reinsurance may seem.

Hurricanes pose a deadly threat to those living in their path and the risk capital provided by the reinsurance and ILS industry is key in helping people recover from disasters. Sometimes conversations in this industry get too focused on the market trends and the motivations of risk capital providers. At times it is necessary to step back and remember that this capital we discuss so frequently is there to be lost and for a very worthwhile reason.

Keep track of the 2014 Atlantic hurricane season, compare forecasts and monitor the progress of storms here on Artemis. Visit and bookmark our 2014 Atlantic hurricane season page.