Hurricane Delta hits major Cat 4 status, threat to Mexico’s cat bond increasing

Hurricane Delta has now intensified into the third major hurricane of the 2020 Atlantic storm season and with further strengthening in the forecast this storm could pose a test for the World Bank issued FONDEN 2020 catastrophe bond sponsored by the Mexican government.

Hurricane Delta became the fastest 25th named storm of any season to form yesterday, then the 9th hurricane of the particularly active 2020 Atlantic tropical storm and hurricane season and now the third major hurricane.

Update, Weds Oct 7th: Hurricane Delta weakened slightly overnight to sustained winds of 120 mph and its minimum central pressure rose to 972mb. With Delta nearing the Yucatan and not expected to intensify further before making landfall there, the latest central pressure readings suggest that Mexico’s World Bank issued FONDEN 2020 catastrophe bond will be safe from loss. After impacting the Yucatan further strengthening is expected once hurricane Delta travels into the Gulf of Mexico and a major hurricane landfall for the U.S. Gulf Coast is now possible.

On course for a United States landfall sometime on Friday into the early hours of Saturday, hurricane Delta has put the insurance, reinsurance and insurance-linked securities (ILS) communities back on alert after a short lull in tropical activity over the last week to ten days.

Having intensified rapidly overnight, hurricane Delta has strengthened significantly throughout today and is now packing Category 4 sustained winds of 130 mph with gusts higher than 150 mph as it moves steadily northwest through the Caribbean.

The tip of the Yucatan Peninsula, Mexico is forecast to receive a direct hit from hurricane Delta as the storm travels generally north-west towards the Gulf of Mexico.

As had been predicted, hurricane Delta has achieved major Category 3 status before it reaches the Yucatan and then very quickly Category 4, so the threat to that region of Mexico looks set to be particularly severe.

Further intensification is now expected and hurricane Delta could pose a very significant threat to the Yucatan region of Mexico, to property, lives and livelihoods.

Given the continued increase in intensity of hurricane Delta as it approaches the Mexican coastline, the potential for the World Bank’s IBRD issued IBRD / FONDEN 2020 catastrophe bond transaction, that provides disaster insurance and reinsurance to Mexico’s Government’s FONDEN catastrophe fund, has come into focus.

This catastrophe bond was issued earlier this year in Q1 and was hailed as an important part of Mexico’s social protection strategy.

In order for holders in that parametric catastrophe bond to be exposed to losses, the minimum central pressure of hurricane Delta would need to dip down to somewhere around 935mb, it appears.

Currently hurricane Delta has a minimum central pressure of 954mb, having dropped from around 975mb early this morning and reflecting the rapid intensification being seen.

Further deepening of the storm is expected as it intensifies further, meaning that the FONDEN cat bond will likely come under increasing scrutiny from cat bond funds and investors today and into tomorrow morning.

The FONDEN 2020 catastrophe bond has a stepped parametric payout structure, with 25%, 50% and 100% payouts of principal possible, depending on the minimum central pressure of a storm as it crosses the parametric box.

The $125 million tranche of Class C notes are exposed to hurricanes on the Atlantic side, where hurricane Delta is situated.

For this catastrophe bond to be triggered it needs the minimum central pressure of hurricane Delta to dip below predefined levels as it breaks a parametric box drawn around the eastern coastline of Mexico. The Yucatan Peninsula is right in the middle of the box and from the information we have it appears a decline in pressure to around 935 mb or lower could threaten the notes with a 25% loss of principle.

Lower still and the loss of principle could step up to 50% or even 100%.

It’s difficult to tell for certain, as we do not have the precise structure details of the parametric trigger available to us.

But it is safe to say that now that hurricane Delta has strengthened significantly and its minimum central pressure continues to fall, cat bond funds and investors that currently hold notes from the FONDEN 2020 Class C tranche will be on high-alert.

The FONDEN 2020 catastrophe bond is designed to support the Mexican Government’s need for post-disaster capital inflows, with the insurance and reinsurance capacity backing the deal sourced from the capital markets to augment FONDEN’s own capital base.

Aside from that potentially exposed catastrophe bond, the Yucatan Peninsula area and regions such as Cozumel and Cancun are in the path of hurricane Delta, putting high-value tourism assets and hotels at some risk.

A previous hurricane, Wilma in 2005, drove a 15 foot storm surge into the Quintana Roo region of Mexico, causing direct insurance industry property losses of over $500 million, analysis from reinsurance broker Guy Carpenter said.

Guy Carpenter explained, “Over 100 hotels were significantly damaged or destroyed, nearly 10,000 homes destroyed and another 19,000 homes significantly damaged. Ultimate business interruption losses from Wilma exceeded property damages due to loss of tourism revenue.”

There is ample insurance and reinsurance capital exposed to hurricane Delta’s expected passage over the tip of the Yucatan and we understand there are some parametric corporate insurance contracts in place with resorts in the area as well.

But the bulk of the insurance, reinsurance and ILS market will be watching for how hurricane Delta reacts to its interaction and possible landfall on the Yucatan and how well it maintains its structure as it heads further north into the Gulf of Mexico, where it could remain a major hurricane as it tracks towards the U.S. coastline.

The latest NHC forecast shows hurricane Delta remaining at major Category 3 or greater strength right up to just prior to landfall, but dipping slightly before coming ashore in central Louisiana.

As ever, landfall location on the Gulf Coast will be key, with the insured losses set to differ significantly depending on the density of high-value industry and property in the immediate landfall area.

The image below from Tropical Tidbits showing modelled forecast guidance on the intensity of hurricane Delta is still mixed, suggesting hurricane Delta could weaken before it reaches the Gulf Coast, but some models suggesting it may sustain major status. As a result a stronger landfalling hurricane cannot be ruled out at this stage and we’ll need to see how Delta looks after it has emerged back over the Gulf of Mexico late on Wednesday, into Thursday.

As well as threatening strong winds that may cause property damage to the Yucatan Peninsula region, hurricane Delta is also expected to bring around 10 inches of rainfall with it and could cause landslides and flash flooding, while storm surge levels of 6 to 9 feet are still forecast, but we expect those to be short now that Delta has reached Cat 4 strength winds and the surge forecasts will likely rise.

For now, hurricane Delta continues to rapidly intensify and is expected to be a very dangerous storm by the time it reaches the Mexican coastline tomorrow morning, putting lives at risk as well as holdings in the FONDEN cat bond.

Once past the Yucatan the focus will be on the Gulf Coast, as the forecast track continues to put hurricane Delta ashore as a hurricane in Louisiana by the end of this week. We’ll keep you updated.

Track the 2020 Atlantic tropical storm and hurricane season with our dedicated page.