A.M. Best warns on Irma’s potential cat bond losses, but exposure low

In a recent report, global ratings agency A.M. Best has warned of the potential impact to Florida exposed catastrophe bonds from the devastation caused by hurricane Irma, but the real exposure for the market is quite low and aggregated losses could be more of a threat.

The overall economic and insured loss from hurricane Irma remains unclear, and will certainly take some time to be fully understood owing to the complexity of the event. Estimates currently suggest an insurance and reinsurance market impact in a range from $20 billion to $40 billion.

The catastrophe bond market has a strong focus on Florida risk, so naturally there’s been discussion and speculation surrounding the potential impact to outstanding Florida exposed bonds.

According to A.M. Best, in a report titled ‘Hurricane Irma’s Potential Impact on Catastrophe Bonds Exposed to Florida,’ roughly $12.5 billion of in-force cat bonds are potentially exposed to Irma.

It’s important to note the word potentially, as currently, and as highlighted by Artemis previously, only a relatively small number of bonds are truly exposed, maybe $1 billion or so worth. In fact, looking at the way loss estimates have been coming down, the cat bond market loss could be lower still (although there is a lot of uncertainty surrounding primary insurer per-occurrence cat bonds still).

A.M. Best’s report is more of a view of how much cat bond principal could have been at risk, had Irma struck somewhere more highly insured like Miami.

According to A.M. Best analysis, which again is subject to uncertainty as it will take some time for the impact to the market to be realised, roughly $2.5 billion of bonds sponsored by Florida-based insurers and Florida-only subsidiaries, are exposed.

With the other $10 billion of potentially exposed deals covering U.S. wind-related perils or U.S. named storms.

Importantly, and as noted by A.M. Best, a catastrophe bond is typically utilised to protect against the most remote, peak exposures, sitting at the top of an insurer or reinsurer’s catastrophe reinsurance program.

This means that an insurer’s retention, reinsurance protection, and any Florida Hurricane Catastrophe Fund (FHCF) protection must be eroded to the attachment level before the bond is triggered.

This further underlines the uncertainty of the actual exposure to the catastrophe bond market.

“A.M. Best believes one potential impact is a change in the behaviour of traditional reinsurers and the use of alternative capital instruments such as catastrophe bonds, collateralised reinsurance programs, sidecar vehicles, and insurance-linked securities (ILS) funds,” said the ratings agency.

Given the collateralised reinsurance segment’s persistent expansion and the fact it typically attaches lower down than a cat bond, this part of the marketplace and other private ILS structures are expected to be more exposed than the cat bond market itself.

“In A.M. Best’s view, insured losses exceeding USD 75 billion would alter the pricing dynamics in the Florida property catastrophe reinsurance market; however, the initial indication from peril modellers is that Hurricane Irma will result in more modest insured losses than this amount,” continued A.M. Best.

Some industry estimates for the overall economic impact of Irma have been as high as $83 billion, while Karen Clark & Company announced recently that it expects the insured loss to reach $25 billion.

One thing that has become clear is that the insured loss will most likely be far lower than the economic hit from the storm, a global trend in both develop and emerging markets that highlights the international underinsurance problem.

“Determining actual losses on outstanding catastrophe bonds will take some time,” said A.M. Best, adding that should the insured loss be high from the storm, it could raise some questions for the ILS space and “could alter the catastrophe bond landscape.”

As Artemis revealed earlier today, investors in catastrophe bonds are showing us which transactions are considered most exposed through their trading activity.