Ratings agencies see aggregate catastrophe bonds and private ILS or collateralized reinsurance contracts as having the greatest exposure to hurricane Harvey’s impacts on Texas, but for losses to occur and be significant the final bill will need to come in at the upper end of industry loss estimates.
Rating agency Standard & Poor’s said that, “Given current loss estimates, we do not anticipate any of the natural catastrophe bonds we currently rate with per-occurrence triggers to be affected.”
The insurance and reinsurance industry loss is expected to fall too far below where cat bonds that provide per-occurrence coverage are structured to pay out, meaning that the majority of cat bonds exposed to the reason are deemed safe from loss as a result.
With private re/insurance industry loss estimates currently ranging from around $5 billion to $20 billion the chances of cat bond exposure are lessened. The majority of per-occurrence structures provide tail protection for their sponsors, so are designed to trigger only in the most severe industry loss events.
AIR said it expected an industry loss of up to $2.3 billion from wind and surge damage caused by hurricane Harvey, while equity research analysts called for a market loss of as much as $20 billion, taking into account commercial flood and other lines of business and business interruption.
However, aggregate catastrophe bonds are another story, as they can accumulate losses eroding the deductibles and aggregating loss activity over a year. As different catastrophe events qualify under the terms of these aggregate cat bonds, the qualifying losses increase, shrinking the amount of future qualifying losses required for the attachment point to be reached.
There is a chance that hurricane Harvey could cause some qualifying losses under aggregate cat bonds, with S&P highlighting two USAA sponsored deals that it rates as potentially at risk.
S&P said that both the Residential Reinsurance 2016 Ltd. (Series 2016-1) Class 13 and Residential Reinsurance 2017 Ltd. (Series 2017-1) Class 13 notes cover losses on an annual aggregate basis, and are exposed to hurricane events in Texas and Louisiana.
Interestingly though, S&P only rated the Class 13 notes in each cat bond deal, while there are two other much riskier Class 10 tranches of notes in these Residential Re transactions which would capture qualifying aggregate losses first. However, S&P only tends to discuss tranches of notes it has rated, so the context of the tranches that might sit beneath them can get a little lost.
Details of USAA’s catastrophe bond arrangements show us that the Class 10 tranches of notes from both ResRe cat bond deals are sitting much further down the aggregate tower and so have a greater risk of losses qualifying and eroding their retention. Meanwhile the Residential Reinsurance 2013 Ltd. (Series 2013-2) Class 2 notes would be the most exposed per-occurrence tranche of USAA sponsored cat bond notes, again as they sit the furthest down the per-occurrence tower.
So, while there could be some aggregated qualifying losses from catastrophe bonds to deal with, raising the risk associated with these bonds for the duration of their current risk periods, it is thought unlikely to be a sufficient quantity of losses from hurricane Harvey alone to trigger any of these.
Likewise, currently the cat bond investment market does not expect Harvey to be a sufficiently large insured loss to impact any per-occurrence catastrophe bonds, even those sitting as low down as the ResRe 2013-2 Class 2 notes we mention above.
The Fonden 2017 cat bond, covering Mexico on a parametric basis, remains a difficult one to call, as it may have to wait for the final tropical cyclone report figures to be released before a determination of its fate is 100% accurate. However, given the pressure was higher than the trigger by a good few millibars when Harvey crossed into the parametric box, it currently seems like this should be deemed safe (although remember Patricia and MultiCat).
S&P notes of the two Residential Re cat bond tranches it rates that; “While losses in excess of the franchise deductible ($50 million) are possible, it is too early to determine what the loss attributed to these two bonds will be. Depending on the covered loss amount, we could take a negative rating action.”
As we said, before these two rated tranches are troubled by aggregating losses the other tranches sitting beneath them would come into play.
Meanwhile, Fitch Ratings said that, as well as impacting insurance and reinsurance companies, hurricane Harvey has, “The potential to also affect collateralized reinsurers and insurance-linked securities (ILS) markets.”
“Collateralized reinsurance and ILS markets also have exposure to Texas property risk but losses would be limited in a less severe insured loss event,” Fitch Ratings continued to explain.
All of this goes along with our earlier article, which stated that catastrophe bond fund managers are not expecting any significant losses (perhaps none at all) from hurricane Harvey, but private ILS interests are expected to see some losses from the event, although this may not be significant as Fitch suggests above.
We have to reiterate that it remains very early for loss projections to be accurate, but at this stage it seems very unlikely that per-occurrence cat bonds will face any loss, likely that aggregate cat bonds will only face an erosion of their buffers, and private ILS or collateralized reinsurance and retrocession is where the majority of the hurricane Harvey loss could fall to the ILS market.