Recent cat bond losses highlight loss creep potential: Icosa Investments

After three recent partial or full defaults of catastrophe bonds due to rising losses from prior period events, Swiss headquartered cat bond fund manager Icosa Investments AG has highlighted the risk of loss creep as something investors need to be aware of when allocating to the asset class.

In an update, Icosa Investments notes that despite there being no recent catastrophe events that have threatened any outstanding cat bond positions, the manager has received reports on three bonds suffering partial or full losses in August.

All of these losses are due to reserves or industry losses developing from earlier events, some as long ago as September 2022, which the investment manager notes, “presents an opportunity to explain a crucial concept—loss creep—and why investors should be mindful of this risk before allocating to cat bond funds.”

First, Icosa highlights a US cat bond that has experienced a partial default due to its sponsors losses from September 2022’s hurricane Ian rising.

This, we assume, is the Hestia Re Ltd. (Series 2022-1) catastrophe bond sponsored by direct-to-consumer and fast-growing insurtech company Kin Insurance.

Right back in October 2022 we highlighted that some investors were looking at the Hestia Re 2022-1 cat bond as one that could be at-risk of potential losses from hurricane Ian.

At the time there was a good deal of uncertainty, but we understand Kin provided an update to investors in the cat bond recently and now it seems a small partial loss of principal is anticipated.

We understand that principal losses are expected to be relatively small for the $175 million of Class A notes issued by Hestia Re in April 2022.

Sources told that Kin has explained that one cause for the loss creep related to hurricane Ian is new litigation tactics being seen in the Florida market, the state where hurricane Ian made landfall.

Kin said that delays in litigation timelines and plaintiffs not settling early are serving to boost litigation charges, which means the average claim size is also rising over time, as too are the number of claims that end up in litigation.

As of this month, the Hestia Re 2022-1 Class A cat bond notes have been marked down by secondary cat bond broker-dealers on pricing sheets.

Marks appear to be in the range of bids from 88 to 93 cents on the dollar, across pricing sheets seen by Artemis, implying the catastrophe bond market believes there is a chance of a roughly 10% loss of principal.

More broadly, Kin’s comments on the litigation being seen in Florida is perhaps also worthwhile highlighting again, as after the enactment of insurance reforms in the state it appears there are new tactics in use that could also amplify losses and loss adjustment expenses for any catastrophes in Florida, which is something for the industry to watch out for.

The second catastrophe bond facing a partial default that Icosa Investments highlights is a European cat bond exposed to losses from 2023’s windstorm Ciaran.

Here, we make the assumption this is likely to refer to the the junior €53 million Hexagon III Re Pte. Ltd. (Series 2021-1) Class B tranche of notes from Covéa Group’s 2021 catastrophe bond issuance.

As we reported back in July this year, these cat bond notes had been marked down, as the market digested the threat posed by the Covéas rising losses from November 2023’s European windstorm Ciarán.

An event notice had already been filed as well, but it seems there could have been an update to this now confirming a level of principal loss for the Hexagon III 2021-1 Class B cat bond notes.

We were told at the time that a reduced interest spread was set to be paid across a portion of the tranche and that the potential erosion of principal to the notes could end up being around €11.2 million, based on the data available at the time.

At that time, the Hexagon III 2021-1 Class B notes were marked down, with some secondary cat bond market pricing sheets having them priced for bids of between 57 and 70 cents on the dollar.

Now, as of early September, cat bond pricing sheets seen by Artemis have the Hexagon notes marked at bids ranging from 50 to 70, suggesting the market sentiment on the potential principal loss has slightly worsened, according to some broker-dealers, but generally hasn’t changed too much from our first report.

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.

This case can only be the full payout of Toa Re Europe’s $25 million Silver Crane private catastrophe bond transaction, after the notes were triggered by a rising industry loss estimate for the Turkey earthquake event from early 2023, which we reported on last month.

Icosa Investments said that, “Fortunately, none of these are part of our portfolios,” but added on the first two cat bonds it mentions, “In the recent cases, loss reserves for Hurricane Ian and Windstorm Ciaran turned out to be too optimistic, leading to partial losses for cat bond investors months or years after the actual events.”

The investment manager added, “Loss creep is a unique risk in the cat bond market. It can impact investors entering cat bond funds, causing financial setbacks from events that may have occurred even long before their investment and which might not be fairly reflected in the valuation prices.

“At Icosa Investments, we actively monitor and manage this risk by typically focusing on cat bonds issued after significant events have occurred. For instance, we are particularly cautious about Florida bonds issued prior to the 2022 hurricane season, considering potential future impacts of Hurricane Ian.”

Demonstrating that loss creep is not always a negative effect for catastrophe bond investors, we’ve learned that the outlook for the Frontline Re Ltd. (Series 2018-1) – Class A that faced losses from 2018’s hurricane Michael has improved.

We’re told that $25.5 million has recently been returned to investors, leaving around $16.6 million in principal remaining, that is marked for bids of 30 to 40 cents at this time.

The sponsor, Frontline Insurance, had already made a roughly $200 million reinsurance recovery from the original $250 million tranche, but this case shows that losses can reduce over time as well, resulting in returns of capital to investors that hold loss-threatened cat bonds.

Details of catastrophe bonds facing losses, deemed at risk, or already paid out, can be found in our cat bond losses Deal Directory here.