How Hurricane Harvey Is Affecting Catastrophe Bonds

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Bonds tied to weather risks tumbled the most in seven months as Hurricane Harvey advanced on Texas’s Gulf Coast.

The Swiss Re Cat Bond Price Return Index dropped 0.44 percent this week, the steepest decline since January. The benchmark, which is recalculated every Friday, had climbed for five straight weeks through Aug. 18.

Investors in the bonds get above-market yields in exchange for the risk that principal could be wiped out by a major disaster in a specified area. Certain securities have been trading, with some at about 95 cents on the dollar by mid-afternoon on Friday, according to Paul Schultz, the chief executive officer of Aon Plc’s investment banking group, which helps companies issue cat bonds.

“There’s no sort of immediate panic in the market,” Schultz said. However, more investors may be affected later in the year if more disasters hit because there are bonds that lump together risks of hurricanes or tornadoes across multiple states.

Hurricane Harvey will be the most powerful storm since 2008 to strike the heart of America’s energy sector, with winds reaching 120 miles (193 kilometers) per hour. The storm is menacing the south Texas coastline, home to as much as half of the nation’s oil refining capacity and a massive network of pipelines that carry oil and gas to the rest of the country.

In addition, Harvey is expected to dump as much as 35 inches of rain on areas of Texas over the next week. Flooding will probably close roads and inundate plants, while strong winds may disrupt utilities’ systems and knock out power to hundreds of thousands of homes and businesses.

Record Issuance

The market for cat bonds and other insurance-linked securities is estimated to be about $86 billion, according to S&P Global Ratings. Issuance of the debt broke a record in the second quarter, with more than $7 billion brought to market, according to Artemis, an industry trade publication.

Hurricanes aren’t the only disasters covered by cat bonds, but they’re among the most talked about, according to Rod Fox, the CEO of risk-management adviser TigerRisk Partners. So even as tornadoes swept through the U.S. with damages at a record rate this year, investors have stuck with cat bonds. Some investors may even flock to the market because it could allow them to charge more in the future for protection against such events, he said.

“Loss activity equals potentially higher prices, which means potentially higher returns,” Fox said.

There have been very few instances where disasters have been severe enough to wipe out the principal of the bonds. Harvey probably isn’t such an event, according to Brett Houghton, a managing principal at Fermat Capital Management, which oversees more than $5 billion for investors including allocations to cat bonds.

“You only expect to lose once every 50 years or once every 100 years,” he said. “We kind of have been through this a few times, and it’s something we’re pretty used to. If you’re not prepared for it, then maybe you shouldn’t be in the business.”