Matthew could hike aggregate cat bond attachment probabilities: RMS

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.

If hurricane Matthew tracks right up to the Florida coast, perhaps makes landfall, and then travels up the coastline as a Category 3 or greater storm, as the forecast suggests it might (see the map), the potential for an insurance and reinsurance industry loss in the billions of dollars is clear.

Most catastrophe bonds are structured such that in order to trigger them it would take a particularly major event, hence their main use-case in protecting against the peak perils. But aggregate cat bond structures also cover multiple, or frequency, type loss events and so even if none were triggered by Matthew the hurricane could erode deductibles and aggregate retention layers, resulting in an increase to attachment probabilities.

Update 11:20 BST / 06:20 ET, Oct 6th 2016: Hurricane Matthew has the potential to trigger outstanding catastrophe bonds and other ILS structures, based on latest forecasts, but significant uncertainty remains and exactly how close the storm gets to making landfall could wildly sway the eventual insurance and reinsurance industry loss.

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.

Ben Brookes, Vice President, Capital Markets at RMS, explained some of the risk modelling firm’s thinking on hurricane Matthew and how if certain scenarios play out they could result in impacts to the catastrophe bond market.

He explained; “Using the RMS North Atlantic Hurricane models we’ve assessed a range of potential outcomes for landfall scenarios, from Miami all the way up to the Carolinas. Expectedly, the broad geographic area produces a large range of scenarios and consequently a very wide range of possible outcomes.

“One scenario, which has been suggested by some of the forecast models over the past 24 hours and the industry hopes to avoid every year, is for Matthew to make landfall near Miami. This scenario could produce losses that rival some of the largest events in recent history. However, the storm is relatively small in its extent, with a narrow wind field and low radius to max winds, so unless the track hugs the coast line it’s likely that the wind damage will be relatively localised, and the chance of a major hurricane strike on Miami is low.”

Brookes said that other hurricane forecast model scenarios that show Matthew tracking further north would likely result in a less severe industry loss for insurance and reinsurance capital, something “potentially as low as mid-single digit billions.”

Citing continued uncertainty around Matthew’s forecast track, Brookes explained that; “It seems quite possible that the storm could meaningfully increase attachment probabilities on aggregate cat bonds with Florida, Georgia or Carolinas exposure,” Brookes explained.

Of course it’s not just aggregate cat bonds at risk. There are also other reinsurance and ILS structures which provide aggregate protection that could also see erosion to retention or deductible levels, thus making them more likely to pay out.

Given the number of catastrophe events this year that have hit reinsurers and ILS fund managers with attritional losses, another larger loss from Matthew could take some aggregate covers much closer to the point of paying out.

Under a worst case scenario even per-occurrence catastrophe bonds could be threatened, although this has a lower probability of occurring, Brookes said; “And whilst less likely, there are also scenarios that could threaten occurrence cat bonds and cause a significant impact to the market.”

But scenarios also exist where losses to the re/insurance industry could be much lower, with cat bond losses likely not a factor at all. This demonstrates the continued uncertainty in the final path hurricane Matthew will take.

“It’s also worth noting that there are forecast models that take the storm back out to sea once it’s been through the Bahamas, in which case the loss to the U.S. would be minimal, with claims being driven by loss from tropical storm force winds and rain, but nothing that is likely to be a major impact for the insurance industry,” said Brookes.

Now, the most recent forecasts are beginning to suggest that hurricane Matthew could recurve out into the Atlantic, with a few outliers suggesting the storm could make a full loop and then track back into Florida again.

That could be a worse case scenario and cause particularly high insurance, reinsurance and ILS losses, as well as raise the potential for a catastrophe bond loss from the storm. It’s not unheard of for a hurricane to do this and if Matthew does curve out the approaching tropical storm Nicole could force it back to the south and then west again. A low probability currently, but something to watch out for.

Brookes said that RMS is monitoring the situation closely and expects to have more clarity on the potential impact from hurricane Matthew in the next day or so.

Even though cat bonds may not be triggered, as they tend to provide protection against the most extreme events, insurance, reinsurance and ILS losses could be relatively high from hurricane Matthew. The current forecast suggests an impact significant enough to cause losses to collateralised reinsurance and private ILS contracts, some ILW’s with lower industry loss triggers could also be hit and for certain some reinsurance sidecars would be impacted as well.

We’ll update you as hurricane Matthew approaches Florida.

Also read our previous articles on hurricane Matthew:

– Hurricane Matthew threat awakens live cat market.

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

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