Tornado-exposed bonds pummelled as hailstones drive US frequency losses
Cat bond investors are signalling their weakening appetite for aggregate deals, as losses from multiple US hailstorms have tallied up in the first half of the year, driving an average price markdown of more than 20% across half a dozen aggregate bonds.
The managers point to the patchy quality of vendor models in the arena of severe convective storms (SCSs) as a factor contributing to pricing volatility on these bonds.
Cat bond price erosion
The cat bond notes whose values have been affected by the storms include Bonanza Re 2023-1 Class B, Residential Re 2021-1 Class 11, Sanders Re 2020-1 Class B and Sanders Re 2022-1 Class B, and Topanga Re 2021-1 Class B.
The Bonanza Re notes are pricing at around 83% of par, Res Re at around 80%, the Sanders Re 2022-1 Class C notes at 83% and Topanga Re, the first cat bond to come from Farmers Insurance, in 2021, is pricing at around 90%, sources said.
This would imply total markdowns or expected losses of $144mn to the bonds, collectively worth $675mn.
The Sanders Re 2020-1 Class Bs are discounted the most heavily, pricing at around 56 cents in the dollar, according to market sources.
These ex-Florida notes from Allstate are offering aggregate and occurrence cover, and can provide $100mn excess $3,976mn with a $1mn franchise deductible – or they can be used as occurrence cover at a similar level to the $150mn of Class A notes that were issued as part of the same deal, with a $100mn excess $2.75bn.
The spread on the Class B notes settled at 12.75% on a 1.09% sensitivity case expected loss (EL).
Allstate posted pre-tax cat losses of $1bn in June, including 18 events estimated at $1.13bn, with nearly 60% coming from wind and hail, and which were partially offset by favourable reserve re-estimates from prior events.
It brought the personal lines carrier’s Q2 cat loss tally to $2.7bn.
Meanwhile, Progressive’s Bonanza Re 2023-1 Class B notes are said to be the closest to attaching, according to multiple sources.
Progressive posted cat losses of $1.3bn for first six months of the year, driven by $1bn of losses in Q2, which was a rise of 94% compared to the prior-year quarter.
The losses reflected severe weather events throughout the US, with Texas, Florida and Colorado contributing just over half of them, the firm said.
It added that the storms in Q2 were broad-based, impacting 35 states overall, with nearly 60% of losses coming from motor, and the remainder from property.
Volatility in portfolio valuations
The spreads on US aggregate deals have generally been good at around 10% or higher and are “enticing for investors”, according to David Strasser, senior portfolio manager at Plenum Investments.
The structures on the deals also have generally moved in favour of investors over recent years, with one example being the change in the deductible on the Sanders Re Class B layer, from a $1mn franchise deductible on the 2020-1 B notes, as noted above, to a $50mn event deductible on the 2022-1 B notes.
However, Strasser said that “year after year” these type of aggregate bonds continue to be marked down, and that a big factor in this was the lack of accuracy in the modelling for US SCSs.
The multiples achieved on aggregate bonds are generally much higher than would be implied by their modelled expected loss (EL), which are often around 1% or less.
However, historically, the models have underbaked frequency-type losses from US SCS, with actual losses reported by cedants "almost always” over-topping the modelled EL, Strasser said.
This year’s higher-than-average tornado activity and the subsequent mark-downs has led Plenum to state that it wants to keep its allocation to aggregate US peril bonds to “a minimum”, while another cat bond investor source said they already had “very little” participation in aggregate bonds for this reason.
Strasser said: “Even though the prices may recover, still it introduces an element of volatility to the portfolio valuations that we don’t love. The models don’t accurately capture the risk, and we prefer to invest in what we understand.”
Hailstones like baseballs
Sources noted that thunderstorms across the southern states from March through June had been the most costly events, with hail the biggest contributor to losses.
Cat loss estimates from Aon Cat Insight, Gallagher Re, Munich Re and Swiss Re all noted that severe convective storms (SCSs) had driven near-to-record-high losses in the first half, with Aon claiming H1 2023 would exceed the previous high of around $33bn H1 2011 for SCS losses.
The total loss figure was around $32bn when averaged across the four reports. The event count was also above average, and the number of events causing losses of $1bn or more reached at least 10.
Modeller Karen Clark & Company estimated that the SCS from 10-19 June that hit mainly in Arkansas, Georgia, Mississippi and Texas caused insured losses of $5.5bn.
The group of storms comprised 50 tornadoes, some rated F3 on the Enhanced Fujita Scale.
Amongst H1 events, Aon data put two storm groups in March and April at or above the $4bn threshold. Occurrence reinsurance is more likely to be at risk with larger events such as these.
Steve Bowen, chief science officer and meteorologist at Gallagher Re said: “SCS activity has been very active. We are now approaching 10 multi-billion dollar loss events, with around 50%-80% of these losses come from hail.”
Exposure growth in urban areas of Colorado, Florida, Texas and across the Midwest is “playing a big part” in elevating losses, Bowen noted, with “more opportunities for hail to cause damage now”.
Climate change, while not necessarily driving up SCS frequency, has warmed the atmosphere and added moisture to the air, resulting in “more days that are conducive for there to be outbreaks”, Bowen added.