Navigating the Treacherous Terrain of Catastrophe Bond Losses

The catastrophe bond market has recently faced a series of partial or full defaults, highlighting the critical issue of "loss creep" that investors must be aware of when allocating to this asset class. Swiss-based cat bond fund manager Icosa Investments AG has shed light on this phenomenon, providing valuable insights for those navigating the complexities of the cat bond landscape.

Uncovering the Hidden Risks in Catastrophe Bonds

The Hestia Re Saga: Litigation Tactics Amplifying Losses

The Hestia Re Ltd. (Series 2022-1) catastrophe bond, sponsored by insurtech company Kin Insurance, has experienced a partial default due to rising losses from Hurricane Ian in September 2022. Kin has attributed this loss creep to new litigation tactics emerging in the Florida market, where the hurricane made landfall. Delays in litigation timelines and plaintiffs' reluctance to settle early have resulted in increased litigation charges and a rise in the average claim size over time. This trend is a concerning development for the industry, as it suggests that even after the enactment of insurance reforms in Florida, new tactics may be employed to amplify losses and loss adjustment expenses for catastrophic events in the state.

The Hexagon III Re Saga: Windstorm Ciaran's Lingering Impact

Another catastrophe bond facing a partial default is the junior €53 million Hexagon III Re Pte. Ltd. (Series 2021-1) Class B tranche, which is exposed to losses from the 2023 European windstorm Ciaran. The market has already digested the threat posed by Covéa Group's rising losses from this event, leading to a downgrade in the pricing of the Hexagon III 2021-1 Class B notes. The potential erosion of principal to these notes could end up being around €11.2 million, a significant impact for investors.

The Silver Crane Saga: A Full Default from the Turkish Earthquake

The third catastrophe bond loss highlighted by Icosa Investments is a full default for a private cat bond that has experienced a total loss from the Turkish earthquake earlier this year. This case refers to the full payout of Toa Re Europe's $25 million Silver Crane private catastrophe bond transaction, which was triggered by a rising industry loss estimate for the Turkey earthquake event.

Mitigating Loss Creep: Icosa Investments' Approach

Icosa Investments has emphasized the importance of actively monitoring and managing the risk of loss creep in the cat bond market. The investment manager typically focuses on cat bonds issued after significant events have occurred, particularly cautious about Florida bonds issued prior to the 2022 hurricane season, considering the potential future impacts of Hurricane Ian.

The Frontline Re Saga: A Glimmer of Hope

Demonstrating that loss creep is not always a negative effect for catastrophe bond investors, the outlook for the Frontline Re Ltd. (Series 2018-1) – Class A that faced losses from 2018's Hurricane Michael has improved. Approximately $25.5 million has recently been returned to investors, leaving around $16.6 million in principal remaining, marked for bids of 30 to 40 cents. This case shows that losses can reduce over time, resulting in returns of capital to investors who hold loss-threatened cat bonds.The recent partial or full defaults of catastrophe bonds due to rising losses from prior period events have highlighted the critical importance of understanding the risk of loss creep in the asset class. Investors must be vigilant in monitoring and managing this unique risk, as it can have significant financial implications, even for events that occurred long before their investment. The experiences of Hestia Re, Hexagon III Re, Silver Crane, and Frontline Re serve as cautionary tales and valuable lessons for those navigating the complex and dynamic world of catastrophe bonds.