Catastrophe bonds and ILS at risk from Hurricane Matthew
The catastrophe bond market faces its largest test yet as Hurricane Matthew approaches the Florida coast. Pensions plans and other bondholders stand to be hit by significant payouts from bonds for hurricane damage. A large proportion of the insurance-linked securities (ILS) market is also exposed to Hurricane Matthew, with the latest data from the National Hurricane Centre suggesting the storm is moving further into high-value real estate territory; furthermore, Kennedy Space Centre and its $1.2bn weather satellite, due to be launched on 4 November, could be hit. While the storm's movement remains uncertain, industry losses could potentially reach into tens of billions of dollars. 

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.



A significant proportion of the insurance-linked securities (ILS) market is exposed to hurricane Matthew now, with the latest update from the National Hurricane Center (NHC) suggesting an intense Category 3 to 5 hurricane will brush the Florida peninsula, perhaps with the eye crossing it to make landfall, and then run along it for a significant proportion of the state’s coastline.

That’s a bad scenario for the insurance, reinsurance and ILS markets, and with the forecast path for hurricane Matthew seeming to slip south a little with each update as well, the point at which Matthew reaches Florida is moving further into high-value real estate territory.

Hurricane Matthew has begun to re-intensify, now reaching 125mph sustained winds and with an expectation that this will continue. Some meteorologists are suggesting that the hurricane could even reach Category 5, which based on the current forecast path could be devastating for parts of the Florida Atlantic coast. The outlook for Florida keeps worsening, as we wrote earlier this morning.

Such a scenario would be very bad for insurance and reinsurance companies, with industry losses in such a case moving towards the tens of billions rather than just billions which would deplete insurer capital, hit reinsurance firms, cause losses to private ILS, collateralised reinsurance layers and sidecars, potentially even triggering some catastrophe bonds.

But uncertainty is a big factor still and while the forecast certainty is rising, as hurricane Matthew nears Florida, the way the storm is expected to hug the coastline means that if it does so a little further out to sea the size of the re/insurance industry loss be dramatically lower than if it makes landfall and then stays right on the coast as it moves north.

Ben Brookes, Head of the Capital Markets team at risk modelling firm RMS explained late yesterday; “If anything, things are more uncertain today than they were yesterday – the range of forecasts seems to have widened, with everything from West Palm Beach landfall to a complete Florida bypass, or landfall in the Carolinas. There are even models predicting Matthew will make a loop in the Atlantic and further impact Florida next week.

“Potential market impacts are therefore still very broad – if Matthew makes landfall in a densely populated area, or closely skirts the Florida coastline around Cape Canaveral through to Jacksonville, we could still be looking at losses that would rival anything in recent history. But that’s a big “if.””

Under any of the more severe modelled forecasts for Matthew the ILS market and catastrophe bonds come into play, with potential industry losses above ten billion dollars.

As we wrote yesterday, some of the aggregate structures in the reinsurance, ILS and cat bond market could be impacted, in terms of becoming more risky as retentions are eroded, due to hurricane Matthew. But RMS feels that a more severe outcome could mean cat bonds are triggered outright.

“In a scenario like this, we could see the ILS market impacted, and with significant bond exposure in Florida, a major industry loss would be highly likely to also mean losses to outstanding cat bond principal,” Brookes commented.

It needs to be stressed that this remains a possibility only under the more severe scenarios for hurricane Matthews impact on Florida and with uncertainty high it’s still too early to forecast any losses.

Brookes explained; “On the other hand, it remains quite possible for Matthew to stay further offshore, or for the damaging winds to affect less populated areas. As yet we could still be looking at a low-single-digit billions industry loss event, which would mean very little impact to the ILS market.”

But whatever happens the ILS and catastrophe bond market needs to remain alert to the fact that there is a good chance it will be called on to pay some claims, due to collateralised reinsurance layers being triggered, and that if the more severe scenarios play out then everything could be in play, including exposed catastrophe bonds.

With a significant proportion of the outstanding catastrophe bond market exposed to Florida hurricanes, perhaps as much as 60% or more of risk capital outstanding, we are likely to see increasing interest in buying and selling cat bonds at more distressed pricing levels as Matthew nears.

Of course that does need someone to be willing to sell at a very low price, as nobody is going to buy a Florida wind cat bond at anything other than a distressed level right now, as well as someone willing to buy and take a speculative punt that the storm misses or its hit is less severe than many forecasts show. The cat bond market does remain in its holding pattern (we’re told) so far this morning, but this may change in the 24 hours to come.

“What’s clear is that the uncertainty that’s unfolding is likely to create trading interest – the market is closely monitoring what’s going on, and in some cases actively hedging,” Brookes said.

As we wrote yesterday, the live cat trading market in ILW’s and catastrophe swaps has come to life on the threat of hurricane Matthew. This is likely ongoing today, if anyone is willing to pay the rising prices that this protection will now cost.

We understand that there has been more ILW buying and that the limits placed on hurricane Matthew are rising, as some ILS funds and re/insurers look to better protect themselves against losses from the storm.

Once hurricane Matthew has navigated its way through the rest of the Bahamas we will have a better understanding of how much it looks set to interact with land in Florida. At that point the scenarios available will likely narrow and the ILS and cat bond market may have a much better view of just how likely losses are and be better able to estimate their size and impact.

Also read our previous articles on hurricane Matthew:

– Barbados to see $975k from CCRIF parametric payout for Matthew.

– Hurricane Matthew hits Bahamas, to intensify – Florida outlook worsens.

– Matthew could hike aggregate cat bond attachment probabilities: RMS.

– 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.