Cat Bond Returns Accelerate as ‘Frankenstorm’ Bears Down

Allstate Among Property Insurers Pressured by 'Frankenstorm'
In this handout satellite image provided by National Oceanic and Atmospheric Administration (NOAA), Hurricane Sandy churns off the coast of Florida in the Atlantic Ocean on Oct. 26. Source: NOAA/Getty Images

Bonds designed to protect insurers from payouts on natural disasters are headed for the best returns since 2009 as a superstorm expected to develop from Hurricane Sandy threatens to strike the U.S. Northeast.

Catastrophe bonds, which lose money if they’re triggered, have returned 10.3 percent this year through last week, more than triple the 2.79 percent gains in the corresponding period of 2011, according to the Swiss Re Cat Bond Total Return Index. The measure, which tracks dollar-denominated debt sold by insurers and reinsurers, includes bonds linked to potential storm damage in the U.S.

Investor demand for the securities has grown with yields on speculative-grade corporate bonds hovering at record lows as the Federal Reserve holds down interest rates to boost the economy. About $1 billion of catastrophe bonds may be exposed to the storm, according to a “loose” estimate by Patti Guatteri of Swiss Re Capital Markets.

“Some investors are looking for bids on specific bonds that are the most exposed to the Northeast,” Guatteri, director of insurance-linked security trading in New York, said today in a telephone interview. “A few things have traded, but nothing at hugely distressed levels, so clearly there is not panic in the market at this point.”

Earthquake, Tsunami

Prices of the securities have gained 2.5 percent this year through last week, boosting the Swiss Re Cat Bond Price Return Index to 95.15, the highest since March 2011.

About $5.3 billion of dollar-denominated cat bonds issued in 2012 have an average maturity of three-years with yields of 9.2 percentage points more than short-term lending rates, according to data compiled by Bloomberg. That compares with a 6.18 percent yield on junk bonds of similar maturities, Bank of America Merrill Lynch index data show.

Returns on cat bonds fell to 3.3 percent last year, with an earthquake and tsunami striking Japan in March 2011, after gaining 11.3 percent in 2010 and 13.9 percent in 2009. On an annualized basis, this year’s gains are headed toward 12.9 percent.

Sandy may combine with a second storm coming out of the Midwest to create a system that would rival the New England hurricane of 1938 in intensity, according to Paul Kocin, a meteorologist in College Park, Maryland, with the National Weather Service, which dubbed the system “Frankenstorm.” The 1938 hurricane killed more than 500 people after crossing Long Island and battering Connecticut and Rhode Island.

‘Mostly Benign’

JPMorgan Chase & Co. analysts Arun Kumar and Brett Gibson last month characterized the 2012 hurricane season as “mostly benign” for insurers, with Hurricane Isaac the only storm to make U.S. landfall and cause notable losses of about $1.2 billion, according to a Sept. 10 report.

“It’s very early to tell what’s going to happen with this storm,” Nelson Seo, co-founder of Westport, Connecticut-based Fermat Capital Management, which oversees more than $3 billion, including cat bonds, said in a telephone interview. “Even if something does happen, it’s probably not enough to wipe out the returns you’ve seen this year.”

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