Catastrophe Bonds, But Not All Investors, Spared Irene Losses

Fears that several catastrophe bonds exposed to Hurricane Irene would experience a loss are now vanishing from the market following initial estimates that are below common trigger levels.

But heavy trading in the secondary market in the days leading up to the storm’s landfall – fueled by concerns of possible significant damage – may mean that some managers pulled the sell trigger early on exposed bonds, and now face a loss as prices rebound this week.

Initial insured loss estimates following Hurricane Irene from catastrophe modeling firms are coming in below the $10 billion threshold.

On Monday, AIR Worldwide estimated that insured losses from Hurricane Irene to onshore properties in the U.S. will be between $3 billion and $6 billion, according to a company statement. EQECAT has issued early estimates of $3 billion in damages while RMS has yet to issue a statement.

Catastrophe bonds in Irene’s path included Johnston Re, which is sponsored by the North Carolina Joint Underwriting Association and the North Carolina Insurance Underwriting Association. Other bonds with northeast windstorm exposure include Longpoint Re II Ltd. (sponsored by Travelers) and East Lane (sponsored by Chubb).

While vehicles like Johnston Re were at risk during the storm, it’s unlikely they will reach the point of being triggered, says William Dubinsky, managing director of Willis Capital Markets & Advisory in New York. “It’s pretty clear that at this point that the damage from Irene will not rise to that level.”

Dubinsky adds that while no bonds will be triggered specifically because of Hurricane Irene, there may be some erosion of the attachment point for bonds that accumulate losses on an aggregate basis.

But avoiding immediate losses is not to say some catastrophe bond investors will not feel some pain.

During the period leading up to Hurricane Irene making landfall, secondary trading in catastrophe bonds pushed prices down as investors looked to flee northeast windstorm risk. The Swiss Re US Wind Cat Bond Price Index dropped from 96.4 to 89 basis on Friday, August 26.

That means not all players will be winners, especially managers that sold catastrophe bonds prior to Hurricane Irene making landfall, says Willis’ Dubinsky. “In the Wednesday and Thursday prior to the storm there was a fair amount of trading, and there could be losses for anyone that sold at a substantial discount,” he says.

Trading may also have been fueled by frightening initial loss estimates. Kinetic Analysis estimated Irene losses at $20 billion prior to the storm making landfall, but cut loss estimates to $6 billion to $10 billion after the hurricane passed. Over the weekend, catastrophe modeling firm AIR Worldwide prepared a preliminary estimated insured U.S. loss range for Hurricane Irene of between $2 billion and $8 billion, but later the firm said the estimate “was disseminated without the consent of AIR.” The modeling firm said that number reflected a “preliminary estimate [that] was provided to AIR clients before Irene made its second landfall in Coney Island, New York.”

Despite the potential losses, there is a potential upside for cat bond managers caught on the wrong side of an Irene trade, Dubinsky says.

“Investors like to see liquidity. It’s what institutions look for,” he explains. “While there may be some individuals who have trades they regret, they can now go to an investment committee and prove that there was liquidity during a stressful market, and the next time they may be willing to allocate more capital.”

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