(Bloomberg) -- The wildfires sweeping through Los Angeles are unlikely to trigger significant losses for catastrophe bonds designed to capture such risks.
Roughly 12% of the $50 billion cat-bond market is currently exposed to wildfire risk, according to Florian Steiger, chief executive officer of Icosa Investments AG, a Swiss-based investment firm. Even in an “extreme scenario,” many of these bonds are likely to be minimally or not affected at all by the Los Angeles fires, he said.
Twelve Capital, another cat-bond fund manager, told clients in a note published Thursday that “the majority of insured losses are expected to be absorbed by primary insurers and junior reinsurance layers, thus unlikely to significantly affect the cat-bond market.”
The fires sweeping across Los Angeles are now on track to cause about $20 billion of insured losses, according to an estimate by analysts at JPMorgan Chase & Co. That’s twice as much as the Wall Street bank had predicted just 24 hours earlier as analysts try to keep up with incoming information.
Cat bonds are typically used by insurers to offload unmanageable risks to the capital markets. Investors can be on the hook if a predefined catastrophe hits, but stand to reap huge profits if it doesn’t. Investors largely dodged payouts after Hurricanes Helene and Milton hit last year, with the Swiss Re Global Cat Bond Index soaring more than 17% in 2024, just shy of the 20% record seen in 2023.
Catastrophe bonds rarely cover fire as a standalone risk, but typically bundle it with larger perils like hurricanes, often in aggregate structures. Losses are based on data points over a year and cat bonds only trigger when a cumulative loss threshold has been reached. That means there’s still the risk that subsequent natural catastrophes will result in losses, especially after last year’s hurricane season.
“The profile of some aggregate bonds has become riskier” in light of the LA fires, Steiger said. “There’s less of a safety margin available for future events,” such as the upcoming US tornado season from March to June, he said.
Over the past five years, however, trigger events have become less common as fund managers use increasingly advanced models to set the terms of the bonds they hold. At the same time, investors have been pushing for higher interest payments in return for taking on the risk posed by higher inflation, rising property values and climate change.
“Investors have been able to obtain more robust structures, making cat bonds safer,” Steiger said.
The deadly fires ripping through Los Angeles have been driven by hurricane-strength gusts that have already forced more than 100,000 residents to flee.
“Expectations of economic losses stemming from the fires have more than doubled since yesterday to closer to $50 billion, and we estimate that insured losses from the event could exceed $20 billion (and even more if the fires aren’t controlled),” JPMorgan analysts led by Jimmy S. Bhullar said in a note.
Wildfires, like floods and storms, are considered so-called secondary perils. Unlike hurricanes, which are primary perils, they have proved harder to model. For that reason, investors are keen to avoid them.
“When you look at the models, there is a divergence between modeled losses and the economic reality” of losses on the ground, Steiger said. So from an investor perspective, “we’re skeptical,” he said.
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