It sounds unthinkable but there is a school of thought that some on Lime Street, home to the world’s most famous insurance market, will quietly take grim satisfaction from what has happened.
Not from the death, destruction and misery that Irma has wrought, of course. Yet the disaster may have longer-term consequences for the insurance sector.
Ever since the financial crisis, a lot of money has flowed into reinsurance, the process in which insurers reduce the risk to themselves from big one-off events by buying insurance from other insurers.
Image: Florida’s coastline has been hit by strong winds and heavy rain
Much of that money has gone into catastrophe or “cat” bonds. These are bonds, generally of no more than three years in duration, that insurers sell to investors to reduce the risk to them of catastrophes like hurricanes. If there is no catastrophe during the life of the bond, investors receive their money back at maturity, plus interest. However, if there is a catastrophe, investors lose their money.
The bonds have been very popular with investors – in particular hedge funds and some pension funds – in recent years because, in a world of ultra-low interest rates, they pay a decent yield.
Issuance of catastrophe bonds hit an all-time high during the second quarter of this year, with some $6bn-worth being sold, while, as of the end of June, some $26bn-worth of such bonds were outstanding.
That has helped the reinsurance industry by providing it with capital. The sector, just before Hurricane Harvey and Hurricane Irma struck, was reckoned to be sitting on more capital than ever – which should help it absorb losses from the two disasters.
Image: Palm trees blow in the wind as Hurricane Irma arrives in Fort Myers, Florida
However, following the recent run of hurricanes, investors in a lot of those catastrophe bonds may be about to lose their money. Getting on for three-quarters of all catastrophe bonds are reckoned to be exposed to US hurricanes. A sign of the scale of possible losses came on Friday, when the Swiss Re Cat Bond return index, which tracks the fortunes of the cat bond market, fell by 16%.
So why might all this cheer the denizens of Lime Street?
Well, while it has helped reinsurers build up their capital cushions, the inflow of money into the sector during recent years has also depressed reinsurance premiums. It has also raised concerns about risk being mispriced – something about which John Nelson, the former chairman of the Lloyd’s market, was warning as long ago as 2013. The sudden hit to catastrophe bonds may cause some investors to rethink their approach to the sector.
Lloyd’s chief executive Inga Beale told The Sunday Times at the weekend: “Almost in a perverse way, when you look at the more medium term, (the hurricanes) can benefit the sector post all of this.”
Image: A truck is turned over as Hurricane Irma passes the city of Miami
Yet the reinsurance sector would be wise not to get too carried away.
The evidence of recent years suggests that, far from deterring investors in cat bonds, natural disasters can also raise interest in them.
The Japanese earthquake and tsunami of 2011 led to a 30% spike in reinsurance premiums – which promptly led to a surge in cat bond issuance in the country. The same effect was seen after Hurricane Sandy battered the coast of New Jersey in late 2012.
So even the recent spate of hurricanes may not drive some of this money out of the reinsurance market. Only a return to a more normal interest rate environment is likely to do that.
Source: Sky News