Ian's fallout will test cat bond investor appetite: Fitch
Insurance-linked securities (ILS) investors not properly compensated for risk or facing elevated losses amid fallout from Hurricane Ian may choose to reinvest capital elsewhere, which would exacerbate the demand/supply imbalance of the reinsurance sector, which is especially acute in the Florida property market, Fitch Ratings says in a new research note.
ILS include catastrophe (cat) bonds, collateral reinsurance, sidecars and industry loss warranties, representing around 20 percent, or $100 billion, of global reinsurance capacity. Cat bonds are approximately 30 percent of the ILS market. Commentary from the Monte Carlo Rendezvous 2022 indicated a pipeline of ILS deals of $5 billion, Fitch said. of additional reinsurance capacity, which would benefit insurers facing a hardening market.
However, the ILS market will assume a fair share of losses from Ian, with Fitch estimating total insured losses of $35 billion-$55 billion, second only to Hurricane Katrina at $65 billion. ($90 billion in 2021 dollars).
As frequency and severity of losses have increased in the past 10 to 15 years, modelling catastrophic losses and pricing risk effectively is challenged by secondary peril costs and potential effects of climate change on catastrophe events, Fitch says. Escalating inflation and litigation expenses also make controlling claim costs more difficult, it adds.
Major hurricanes have hit Florida in five of the past six years, following a 10-year reprieve after Katrina (2005). The state remains attractive with its population growing over 16 percent, or three million people from 2010 to 2020. Estimated losses from Ian will make the “tenuous” January 1 renewal season much more difficult, Fitch says.
ILS investors are compensated for possible principal loss due to natural catastrophe risk. Since 2017, with insured losses from Hurricanes Harvey, Irma and Maria, the number of cat bonds not returning full principal to investors totals 55 individual tranches with either a full or partial loss to investors, a dramatic increase compared to 75 tranches in totality since 1990.
Nearly 33 percent, or $10 billion of outstanding cat bonds, have some exposure to Florida wind damage, Fitch notes, and ILS investments exclusively or predominantly exposed to Florida wind or the southeast region and Hurricane Ian are $2.9 billion.
“Without proper compensation, investors will look elsewhere. Cat bonds become unattractive if investors perceive they are not adequately compensated for ‘loss creep’ and ‘trapped capital’ due to settlement delays, which can last three to four years,” Fitch said.
“During this time, cat bond investors may forego investment opportunities from other asset classes or be stuck with ILS deals at lower spreads.”
ILS-trapped capital from Hurricane Ian is estimated at $15 billion-$18 billion according to Trading Risk.