(Bloomberg) -- The cost of issuing catastrophe bonds looks set to go up, as asset managers who specialize in the securities react to the fallout from Hurricane Milton.
Though cat-bond portfolios will likely see a much smaller dent than initially estimated after Milton, “every loss withdraws risk-bearing capital from the market and reduces reinsurance capacity,” Plenum Investments Ltd. told investors in an emailed update on Saturday. As a result, “risk premiums in the cat-bond market are likely to increase again” from what’s already an “historically high level,” it said.
The prediction comes despite evidence that investors may now be facing minimal losses. Milton, which ripped through Florida as a Category 3 hurricane in the early hours of Thursday, may have caused less than $60 billion in damages, compared with earlier predictions of more than $100 billion, according to Bloomberg Intelligence.
“It played out in the end a bit better than at some point was forecast,” Tanja Wrosch, head of cat-bond portfolio management at Twelve Capital AG, said in an interview with Bloomberg Television on Thursday.
Current estimates show that the cat-bond market looks to have dipped just 1.34%, according to Artemis, which cited end-of-week pricing calculated by Swiss Re Capital Markets. The US wind specific version of the index fell 3.64%, it said. Earlier in the week, forecasters had warned of losses as deep as 15%.
The risk premium was about 6.5% as of Sept. 27, on top of which investors receive the Treasury rate of about 4.6%, according to Artemis.
Catastrophe bonds are issued by insurers, reinsurers and governments to provide financial protection against the most severe natural disasters. Investors who buy the bonds stand to make sizeable gains if a predefined event doesn’t occur, but can lose much of their capital if it does. That capital is then used to cover insurance claims.
Cat bonds have so far been spared a major trigger event in what meteorologists are calling one of the most active hurricane seasons in recent memory. The bonds benefit from carefully calibrated terms calculated by some of the finance industry’s most sophisticated analysts.
While cat-bond investors look to be facing minimal losses after Hurricanes Helene and Milton, the picture on the ground remains dire for millions of people.
Last year, cat bonds underpinned the most profitable hedge fund strategy of them all, namely insurance-linked securities, according to an analysis provided by Preqin.
After Hurricane Ian hit in 2022, the Swiss Re Index took an initial hit of more than 10%, but the market recovered quickly and the index ended the year down just 2%. Those losses were still enough to lead investors to demand meaningfully higher risk premiums, helping drive up returns. In 2023, the Swiss Re cat-bond index soared a record 20%, trouncing returns across other key debt markets.
Plenum said its prediction that risk premiums will rise depends on a number of parameters, including final claims, meaning the ultimate outcome remains “difficult to estimate.”
©2024 Bloomberg L.P.