Cat Bond Damage Looks Overdone, Even as Flood Risk Looms

(Bloomberg Gadfly) -- Hurricane Irma may be downgraded to a tropical depression by Tuesday, according to the U.S. National Hurricane Center. The insurance industry is breathing a sigh of relief.

This should be reflected in prices for catastrophe bonds too. The benchmark Swiss Re index took a nasty tumble at its weekly update on Friday, before Irma hit Florida, and that is probably well overdone. 

AIR Worldwide on Monday lowered its top estimate for U.S. insured damage from Hurricane Irma to $40 billion from $50 billion, maintaining the low end its expected range at $20 billion, according to Artemis. Data modelling firm Enki Research cut its projection for total losses to $49 billion from $200 billion. 

On Saturday, risk modeling company RMS said there's only a 10 percent chance that wind losses from Irma will exceed $60 billion, and the firm will surely lower that estimate. That should give a boost to the cat bond market, as 60 percent of it is linked to wind damages. 

The weighting toward wind makes sense, as it's much easier to model. Flood is a different matter -- it's much harder to project losses, and so comprises a much smaller part of the catastrophe bond market, which itself occupies one corner of the reinsurance sector known as the insurance-linked strategies market.

ILS is much larger than cat bonds, and includes bespoke securities arranged for hedge funds, or otherwise traded on a bilateral basis. Instruments linked to flood risk are dispersed across the ILS market, and a wobble in one of them need not affect the whole sector. As concern begins to shift from the initial storm hit to the damage from rising water levels, it looks like both the ILS and cat bond markets will be able to cope with the damage, and the rest of the U.S. storm season.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

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