As yet another hurricane bears down on the US, the insurance press is reporting a surge in Cat Bonds and other alternative capital. Cat Bonds and the amounts reinsured are apparently at a high. Cat bonds, as we know, respond to catastrophic loss events. Cat Bonds exist for various types of large property loss events, but windstorms make up the majority of the Cat Bonds. When the wind doesn’t blow, the Cat Bond investors make a nice profit. But when the wind blows, the Cat Bond investors often lose their investment because the bond has to pay based on the parametric trigger, often an industry wide loss figure. The projected losses for Harvey are quite large and with Irma bearing down on Florida, the projections are going to skyrocket. While you may think Cat Bonds simply either have to pay or don’t depending on the declared loss, in fact, there are some issues that have arisen that need to be considered as this string of hurricanes parades across the Southern US.
There is very little case law on Cat Bond disputes. The one most known, Mariah Re, Ltd. v. American Family Mut. Ins. Co., was a Second Circuit affirmance by summary order of a New York federal court’s holding that the Cat Bond had to pay out to the cedent even though the trigger–here a PCS catastrophe bulletin–had been amended after the record date. We discussed this case in our December 2014 Reinsurance Newsletter. Cat Bonds trigger based on the occurrence of a specific event. Often it is an agency like the Property Claims Service that is used to set the loss event by a date certain. If the total loss reaches the trigger, the Cat Bond pays. In this case, the initial catastrophe bulletin calculated a weather event in a certain way, which did not trigger the bond, but then supplemented its bulletin and recategorized the weather event in a way that triggered the bond. The Special Purpose Vehicle reinsurer tried to avoid payment based on the supplement occurring after the record date, but the court rejected the argument based on the plain language of the agreements.
What this case teaches us is that the technical terms of the Cat Bond and related documents–particularly the trigger terms and the occurrence or event that will cause a trigger–have to be negotiated and drafted carefully and then examined carefully to determine if, in fact, a triggering event has occurred. While a parametric trigger is meant to simplify the process of recovering after a catastrophic loss, the actual words of the agreements matter, especially when the loss is likely to be significant. If the Cat Bond triggers on an industry loss figure from an independent agency like PCS reaching a dollar threshold, then examination of when and how PCS reaches that conclusion will bear on the obligation to pay. As in the Mariah Re case, sometimes these triggers are based on geography as well as the dollar size of the loss and are set at a record date. These requirements differ from bond to bond.
As Irma bears down on Florida, those ceding companies (and others) staring at their Cat Bonds need to carefully consider the technical requirements that will trigger payment. Those investors in alternative capital vehicles that cover Florida hurricanes should also carefully examine the wording, because if the forecasts hold up, the wind will blow and the Cat Bonds will trigger.