The catastrophe bond market is poised for a record year as climate change causes an increase in extreme weather events and related disasters. But potential losses from hurricanes Helen and Milton could test investors’ risk tolerance.
Created after Hurricane Andrew hit Florida and Louisiana in the 1990s, cat bonds are a way for governments and insurance companies to spread the risk of disaster losses into capital markets, allowing investors to profit from that risk. It is also a means of obtaining. News and data service Artemis.bm has tracked more than $13 billion in new bonds so far this year, with market capitalization now approaching $48 billion.
Steve Evans, owner and editor-in-chief of Artemis, said there are two main reasons investors like catastrophe bonds. First, because of their higher risk, they tend to pay higher returns than traditional bonds, recently around 11%.
“Returns have been good the last few years and that always helps,” Evans said.
More importantly, he said, cat bonds provide a form of diversification for investors. It does not move in conjunction with stocks or other assets.
“They are largely isolated from broader financial markets, so investors probably see other asset classes as more attractive options to provide some income during volatile times,” he said. “It has been done,” he said.
Here’s how it works: Insurance or reinsurance companies, and sometimes governments, sponsor bonds that cover losses from certain events. Examples include named tropical cyclones in the Atlantic, wildfires in the United States, and storms in Europe. Investors in a bond pay money into a trust that the sponsor can only access if an event occurs and certain thresholds are met, such as total insured losses or a certain wind speed, and the bond is “triggered.”
If this happens, investors may lose some or all of their funds.
“And if the event doesn’t happen… investors will get their money back and interest,” said Chris Grimes, who follows the market as a senior director of insurance at Fitch Ratings.
Grimes said it was too early to know whether Hurricanes Helen and Milton would result in significant losses for cat bond investors as insurance companies begin processing claims. Like other bonds, catastrophe bonds trade on the secondary market after they are issued. Grimes said the prices of a small number of bonds in the secondary market have initially fallen by 10% to 30%, suggesting investors are expecting some losses.
“What typically happens with events like this is that we see an initial drop in price, but then as it becomes clearer over the weeks and months, the bond price reacts to new knowledge about the actual security itself. I can see that,” he said. .
As of this week, Evans estimated that damage from Hurricane Milton could cause losses for investors in the low $100 million range.
“While this is not a severe event for cat bonds, it is a more severe event for the insurance and reinsurance market as a whole, with estimates ranging from approximately $15 billion to $20 billion, up to around $40 billion.” Mr. Evans said.
Also, if insurance companies issue new catastrophe bonds in the coming months, they may have to pay higher premiums to attract new investors, Grimes said.
“We expect pricing to reflect the greater loss activity that we have just experienced in the past few weeks,” Grimes said.
That could be passed on to insurance customers. One reason the cost of homeowners insurance has risen over the past few years is the rising prices of catastrophe bonds and traditional reinsurance, which helps insurance companies pay claims after a disaster. is.
Cliff Rossi, a risk management expert at the University of Maryland, said cat bonds play an important role in stabilizing the insurance industry.
“But as I see today, the market is not yet large enough to be able to keep up with the pace of extreme weather events that we are starting to see, for example with back-to-back hurricanes,” he said. Said.
How much the cat bond market grows will depend on how much investors continue to expose their capital to risk as climate change combines.
There’s a lot going on in the world. For everything, Marketplace is here for you.
You use the Marketplace to analyze world events and communicate how they affect you in a factual and approachable way. We rely on your financial support to continue making that possible.
Your donation today helps power the independent journalism you depend on. For as little as $5 a month, you can help sustain our marketplace. This allows us to continue reporting on the things that matter to you.
