Strengthening Hurricane Polo brings Mexico catastrophe bond into focus

Hurricane Polo is rapidly intensifying off the southwestern coast of Mexico and the strengthening trend is expected to continue, while the track remains uncertain at this time, which has brought the $175 million IBRD CAR Mexico 2024 (Pacific) parametric catastrophe bond into focus this week.

Polo quickly moved from depression, to tropical storm, to hurricane and now to major hurricane with currently Category 4 sustained winds estimated at 130 mph and higher gusts.

Meteorologists seem to anticipate major hurricane Polo reaching Category 5 status in the coming hours, as it moves over extremely warm waters off the southwestern coast of Mexico.

With the still strengthening El Nino in effect in the Pacific, the waters off the coast of Mexico are plenty warm enough to sustain a very strong hurricane at this time and conditions have seen the region light up with multiple tropical systems in recent days, with a chance of more to come.

Currently, most forecast models suggest major hurricane Polo won’t make landfall immediately, but may track further north west and eventually perhaps make landfall around the Baja peninsula.

However, the current location of hurricane Polo is close to the Mexican coastline and any wobble in the path as the storm moves forwards could bring it much closer to the coastline and the parametric box of the catastrophe bond, which runs just off the shore.

You can see the current location of hurricane Polo and its forecast path below, in this graphic of the NHC forecast from Tomer Burg:

As you can see, hurricane Polo is forecast to move parallel to the Mexico southern coast as it tracks west, with the current position showing an abrupt turn and there being some uncertainty over how sharp that turn will be.

Any deviation closer to the coastline of Mexico could take hurricane Polo very near to the IBRD Mexico 2024 catastrophe bond’s parametric trigger box arrangement, which runs up the coastline. So there is some uncertainty, perhaps sufficient to consider the cat bond on-watch for now.

Further down the forecast path for hurricane Polo, numerous model runs also show the storm curving back towards the Mexican coast, with others bringing a landfall on the Baja peninsula.

You can see the model uncertainty in the graphic below from Tomer Burg:

Each of the lines on the graphic above represents a model run for hurricane Polo, with numerous showing a potential landfall and a good number showing the potential for the storm to get close enough to the Mexican coastline to breach the parametric trigger box design.

The $175 million of IBRD CAR Mexico 2024 (Pacific) parametric catastrophe bond notes feature a parametric trigger design that requires a storm to have a minimum central pressure at or below specific levels in order to trigger a payout if it moves across the parametric box.

Different areas of coastline have different payout factors attached to them as well, so location and intensity are the two key metrics for defining whether any payout will occur and those payouts can be from 25% of principal, right up to the full 100% or $175 million, depending on where any hurricane breaches the parametric box.

There is meaningful uncertainty still at this time, due to the fact hurricane Polo will turn and move back towards the northwest along the Mexican coast, but any shift closer to the coastline could bring the catastrophe bond’s parametric box arrangement into the storms path.

At the same time there is uncertainty further out, in how and when hurricane Polo may turn back towards Mexico, as well as in how intense the hurricane actually is at that time, so how low its minimum central pressure is. There’s also uncertainty in how Polo may interact with other storms, such as Odalys and a yet to develop system that some forecast models show following a similar path in the coming days.

Hurricane Polo would need to continue intensifying and deepen its central pressure to get close to becoming a triggering event for Mexico’s catastrophe bond though.

The latest NHC update estimates the central pressure at 955mb, where as for the cat bond to be triggered a storm must pass the parametric box with central pressure at 937mb or lower, we understand.

As a result, while the threat is there with hurricane Polo, at this time we need to see the situation develop further, in terms of the storm’s track and intensity for the cat bond to really be threatened.

Helpfully, Isacco Loconte, an insurance-linked securities (ILS) Investment Specialist at asset manager Azimut Switzerland SA, posted his thoughts on hurricane Polo on LinkedIn yesterday.

Loconte said that running 1,000 members of Google WeatherLab’s r2 ensemble model shows 77 scenarios where the Mexico Pacific hurricane catastrophe bond is triggered, with potential losses ranging from the 25% all the way up to the full 100% of principal.

Loconte also noted that he had seen some price adjustments in secondary market offers for the cat bond, which might suggest a heightened perception of risk at this time due to hurricane Polo.

Loconte also stated, “Polo is a perfect reminder that high reactivity is an intrinsic feature of parametric Cat Bonds. While the market values these structures for their rapid, transparent payouts compared to the lengthy loss-adjustment process of traditional indemnity bonds, that exact same sensitivity applies to live events. The moment a storm approaches the box, the risk profile – and consequently the secondary pricing – shifts instantly.”

At this time, should hurricane Polo follow the NHC cone forecast, it does not appear that the catastrophe bond could be triggered, it would remain offshore while at its most intense and if it turns into Baja it would be as a weaker storm, likely with higher pressure and so unable to activate the parametric trigger.

But things can change and the uncertainty surrounding Polo’s expected turn makes it a storm to keep an eye on today.

We’ll update you should the threat to the Mexico Pacific coast hurricane catastrophe bond change for the worse, as the hurricane Polo situation develops.