Cat bonds in holding pattern, Florida on watch for hurricane Matthew

At this time the catastrophe bond market has not shown a significant reaction to the slow approach of hurricane Matthew towards the U.S. coastline, despite the fact that the forecast path has been shifting steadily nearer to Florida with each NOAA update and now a hurricane watch has been announced.

Update 08:00 BST / 03:00 ET, Oct 6th 2016: Hurricane Matthew is battering the central Bahamas, with sustained winds of 115mph, higher gusts, torrential rain and a storm surge estimated at anything up to 15 feet. Matthew is then forecast to intensify again and head for Florida, where the outlook is worsening for the state..

Update 15:20 BST / 10:20 ET, Oct 5th 2016: Hurricane Matthew has the potential to be a significant loss event for the insurance and reinsurance industry. It could also cause issues to some catastrophe bonds, eroding aggregate retention and increasing their attachment probabilities, according to Ben Brookes of RMS..

Update 11:15 BST / 06:15 ET Oct 5th 2016: The so-called “live cat” market has come to life, albeit perhaps tentatively, as hurricane Matthew’s approach towards the U.S. has increased the certainty of what looks set to be a relatively major impact (at this time) with a number of ILW’s trading and as much as $100m of limit placed.

Hurricane Matthew remains a Category 4 storm with sustained winds of 145mph as it blasts Haiti and heads for Cuba, followed by the Bahamas.

Damage and destruction there is sadly assured, however it is what happens after that, from Thursday onwards, that is now crucial for the insurance, reinsurance, ILS and catastrophe bond market.

With the forecast track directing hurricane Matthew ever closer to Florida, the state now sits firmly within the cone of uncertainty and the current path shows the center of the hurricane perilously close to the coastline, the ILS and catastrophe bond market is watching the developing situation closely.

In fact in an update just a few minutes ago Florida has been put on hurricane watch by the NOAA, with a hurricane watch in effect from Deerfield Beach, Florida to the Volusia/Brevard county line. A tropical storm watch is also in effect from the Seven Mile bridge in the Florida Keys northward to south of Deerfield Beach, including Lake Okeechobee.

The reason for Matthews track moving steadily west is that another storm has formed, tropical storm Nicole, which is set to squeeze Matthew from the east and could force it nearer to the U.S. shore.

Almost 22% of the outstanding catastrophe bond market, or around $5.46 billion of risk capital outstanding, is exposed to U.S. named storm and hurricane risk. Of that, the majority has exposure in Florida or other eastern U.S. states that could be threatened by hurricane Matthew.

Additionally, another 23% or almost $5.7 billion of the outstanding catastrophe bond market is classified as U.S. multi-peril, the majority of which has U.S. named storm and hurricane exposure and the bulk of that would be exposed to a Florida landfall from hurricane Matthew.

Another 18.7% ($4.86 billion) of the market is classified by Artemis as international multi-peril cat bonds, with again the vast majority of these also exposed to U.S. hurricane risks.

In total, around 60% of the outstanding catastrophe bond market remains exposed to U.S. hurricane risks to some degree.

Exposure to Florida named storms and hurricanes is still the dominant peril across the entire cat bond, ILS and collateralised reinsurance market of course, with Florida considered ground-zero for catastrophe bonds and insurance-linked securities (ILS) funds.

But, despite this potential exposure to hurricane Matthew, the ILS market and catastrophe bond investment funds is currently in a bit of a holding pattern, as it waits for greater certainty to emerge over the eventual path of the storm and whether a U.S. landfall will occur.

Zurich Switzerland specialist catastrophe bond and ILS fund manager Plenum Investments said earlier that “The CAT bond market shows no reaction at this point in time” as there is considerable uncertainty in the storms path at this time.

We’ve spoken to some of the brokers who trade catastrophe bonds in the secondary market and are told that there was a little activity as Matthew developed last week, as some specialist ILS investors sought to offload cat bonds that were particularly exposed to a potential Florida landfall.

That is interesting as the initial forecasts predominantly showed Matthew curving northwards harmlessly out into the Atlantic after passing the Bahamas. Some ILS investors are clearly using some of the outlier weather models which had been suggesting a chance of a landfall for a few days now.

We understand from one broker that a few trades were completed last week largely in Florida hurricane cat bonds, with pricing at reasonable levels, as Matthew was developing. But other brokers said despite there being interest to sell, buyers were few and far between.

But the majority of ILS investors at this time are watching and waiting for greater certainty in the forecast path of hurricane Matthew to emerge before any uptick in trading activity occurs.

There needs to be more certainty on the forecast track of hurricane Matthew before activity would pick up. Nobody wants to be seen as selling a cat bond too cheaply when a loss then fails to mainfest and equally nobody wants to be seen to buy at just a few points below current pricing to then get hit by a hurricane and lose the position. As more definitive news comes out trading may pick up, we’re told.

One of our sources said that a scenario risk model, we’re unsure from which vendor, shows that hurricane Matthew could be as much as a $25 billion insurance industry loss through wind, storm surge and other impacts.

That’s a significant loss for the industry, although potentially at levels below where the majority of catastrophe bonds come into play as most attach high up in reinsurance towers.

However a $25 billion loss would certainly bring industry loss warranties (ILW’s) and collateralised reinsurance layers into play, as well as add to aggregating losses suffered by reinsurance sidecars in 2016.

But that is the forecast of a modelled scenario if Matthew strikes Florida at major or near-major status, so at this time is an outlying possibility, although one that the market should certainly remain aware of.

As reinsurance, ILS fund, sidecar and catastrophe bond risk capital is so heavily concentrated in the U.S., particularly in Florida and other key states, any hurricane that approaches the coastline has the potential to trigger trading in any of those instruments which have liquidity.

Catastrophe bonds are one such instrument (as are a few sidecar notes). But of course, even if some holders want to sell for fear of losses they could face there is no guarantee that the market will be awash with buyers.

Nobody will want to take on a risk that looks set to be triggered, except the more speculative investors that tend to watch the ILS market for distressed investing opportunities. Similarly nobody wants to sell a position that is only possibly at risk.

Until enough certainty emerges in the forecast for hurricane Matthew to kick-start any catastrophe bond trading, this holding pattern will likely persist as investors and ILS managers wait to see what the next few updates from NOAA bring.

Also read:

– Florida, U.S. east coast now face risk of hurricane Matthew landfall.