Owners of 'catastrophe bonds' are staring down big losses as Hurricane Milton barrels down on Florida

• Hurricane Milton may cause major losses for catastrophe bond investors.
• Cat bonds transfer the risk of weather events to investors, offering high returns in years with little damage.

The back-to-back barrage of Hurricanes Helene and Milton could trigger big losses for investors in catastrophe bonds.

The fixed income securities allow insurers and reinsurers to transfer risks associated with major weather events to investors.

Investors who buy cat bonds can see big returns if it's a relatively quiet year for hurricanes and other natural disasters. As long as there are few extreme weather events or damage from any event is mild, investors continue to collect the relatively high yield on the bonds.

That's what happened in 2023, as there were just a few major hurricanes relatively tame in terms of the damage they brought to Florida and surrounding states.

The Swiss Re Global Cat Bond Index surged 20% in 2023, nearly matching the S&P 500's 24% gain last year. The solid returns reflected the sleepy hurricane season last year.

However, on the other hand, a strong hurricane can trigger various clauses within catastrophe bonds, resulting in big losses for investors.

The money that would otherwise flow to bondholders is instead used to help pay out money to policyholders affected by natural disasters.

In 2022, Hurricane Ian caused about $60 billion of insured losses and triggered a big loss in cat bonds, with the Swiss Re Global Cat Bond Index plunging 10% in September 2022. The index dropped 2% for all of 2022.

According to data from Artemis, 2022 was the only down year for the Swiss Re Global Cat Bond Index in 20 years.

Cat bond investors could see a repeat of 2022, or worse this year, if the worrying projections for Hurricane Milton pan out. The storm is barreling towards the west coast of Florida as a Category 4 hurricane, scheduled to hit the state late Wednesday or early Thursday.

Initial estimates suggest Milton could trigger more than $100 billion in damage, according to analysts at Jefferies, with a massive storm surge expected to flood a wide swath of Florida's west coast.

According to RBC, Milton could cause insured losses of about $60 billion, which would likely be big enough to trigger losses on cat bonds.

"Market seems to be pricing in a similar impact from Hurricane Ian of a $60bn industry loss in 2022," RBC analysts said of Hurricane Milton.

This comes just two weeks after Hurricane Helene ravaged parts of Florida and North Carolina, creating estimated losses for insurers of as much as $11 billion, according to an estimate from Verisk.

The Stone Ridge High Yield Reinsurance Risk mutual fund, which owns cat bonds, has plunged 7% over the past month, erasing its year-to-date gains.

Meanwhile, the Pioneer Cat Bond Fund has declined 2% in the past week.

However, according to RBC, higher reinsurance rates implemented following Hurricane Ian could soften the blow for cat bond investors, depending on the severity of Hurricane Milton.

"Better reinsurance contract terms, broader earnings diversification and bigger reserve buffers should put the sector in better stead than before," RBC said.

The potential for massive damage caused by Hurricane Milton, which is considered to be a once-in-a-generation event, is also dragging down global reinsurer stocks.

Shares of Swiss Re and Munich Re are down 3% and 2% in the past week, respectively.