Still a good time to invest in cat bonds despite active hurricane season forecasts: Plenum

With numerous forecasters predicting a very active hurricane season for the months ahead, the distribution of catastrophe bond fund returns over the year and the fact spreads remain elevated, means that now is a very good time to invest in the cat bond product, according to Plenum Investments, the Zurich-headquartered manager of insurance-linked securities (ILS) and related assets.

This was one of the messages from Plenum during a recent webinar, which in part focused on the 2024 Atlantic hurricane season, given the potential for a very active season, which started on June 1st and runs through the end of November.

As explained by Dirk Schmelzer, Senior Fund Manager ILS at Plenum, while there’s not yet been a storm, the prediction from all the forecasters is that it’s going to be an active season in 2024, driven by very warm sea surface temperatures in the Atlantic, and the expectation of a transition to a La Nina scenario.

But while conditions are favourable for storm development, it’s always important to remember that it’s not storm formations that drive industry losses, but hurricane landfalls in populous areas. So, by no means does an active season translate into a high level of industry losses. But of course, the more storms that form in the Atlantic the more chance of a landfall, and therefore the more chance of industry losses.

As an example, Schmelzer highlighted the year 2020, which was very active with 30 named storms, of which 13 became hurricanes, and six of these became major hurricanes. In total, 12 storms made landfall on the US coast, six of which were hurricanes, although just one of these, Hurricane Laura in Louisiana, made landfall as a major storm.

“It turned out that the losses generated in this particular season, with many landfalls across the US shoreline, did not produce significant insurance losses,” said Schmelzer.

However, it’s important to remember that it does also work the other way, meaning that it only takes one major landfall in a densely populated region to drive significant insurance and reinsurance industry losses.

Regardless of a very active storm season in 2024, Plenum emphasised that now is still an optimal time to invest in the cat bond marketplace.

One of the reasons for this, according to Daniel Grieger, Managing Partner, Senior Portfolio Manager at Plenum, is because the returns generated in the cat bond space are “heavily skewed to the second half of the year.”

“We showed in one of the earlier slides how the distribution of return is over the year and the bulk of the performance is made during the hurricane season. This is the nature of the cat bond market. And given the elevated spread level and the fact that most of the performance is still ahead of us, this is definitely a very good moment to invest,” said Grieger.

“We have also seen, from a risk reward perspective, that actually there are not many events that would cost us money on a net basis. If you take a full year into account, there are only two historic events which cost more than an annual premium. So, it’s definitely the right moment to invest,” he added.

Expanding on this, Schmelzer highlighted the diversification benefit of a cat bond investment, noting that from any ILS investment, you are shielding yourself against interest rate risk and credit risk.