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The recent wildfires in Los Angeles, California, have significantly affected the insurance-linked securities (ILS) market. According to Twelve Capital, a leading ILS manager, two catastrophe bond structures are likely impacted by the losses from these wildfires. While primary insurers and junior reinsurance layers are expected to absorb most of the losses, the extent of damage is still being evaluated. Industry loss estimates range from $20 billion to $45 billion, with an average midpoint of $31.125 billion. The impact on aggregate structures remains uncertain, but erosion has been noted, potentially lowering the threshold for future events to trigger losses.

Initial Assessment of Affected Catastrophe Bonds

Twelve Capital's latest analysis indicates that two specific catastrophe bonds are currently at risk due to the Los Angeles wildfires. These bonds feature occurrence-based structures, which means they are triggered by individual catastrophic events. Despite this exposure, Twelve Capital has strategically managed its portfolio to limit potential losses. The company has either excluded or reduced its investment in these bonds, minimizing the impact on their overall financial health.

One of the affected bonds is the Topanga Re Ltd. (Series 2021-1) catastrophe bond issued by Farmers Insurance Group, with $100 million in Class A notes. Initially marked down, these notes showed some recovery after Farmers released its first loss estimate. However, the extent of principal erosion remains uncertain. Another affected bond is the private Randolph Re (Series 2024-1) catastrophe bond, providing indemnity per-occurrence reinsurance to Mercury Insurance. This bond has seen a significant drop in pricing, indicating potential losses for investors. Both deals are currently at risk of triggering, though the exact outcomes remain unclear.

Monitoring Aggregate Erosion and Future Implications

Beyond the immediate impact on occurrence-based structures, the wildfires have also influenced aggregate catastrophe bonds. These bonds are designed to cover multiple events over a period, and the recent fires have contributed to the erosion of their attachment points. This erosion reduces the severity threshold required for future events to trigger losses, making these bonds more vulnerable. Twelve Capital is closely monitoring the situation, awaiting further updates from cedants to assess the full extent of the damage.

The broader implications for the ILS market are significant. As industry loss estimates continue to evolve, there may be read-across effects for other catastrophe bonds. Some re/insurers might be working with higher loss estimates, which could influence where ultimate losses settle. This uncertainty adds complexity to the market, requiring vigilant monitoring and strategic adjustments. The ongoing evaluation of aggregate erosion will play a crucial role in determining the long-term impact on the catastrophe bond market.