Uh Oh: Registered Investment Advisors Look To Catastrophe Bonds

The last major -defined as category 3 (111 mph winds) or above- hurricane to make landfall in the U.S. was Wilma on October 24, 2005. Sandy, with all the flood damage was not at hurricane strength when it landed. As we noted in 2013:

...The major risks that cat bond owners are betting against are landfalling hurricanes in the U.S. and wind storms in Europe.

The only major payout on a hurricane for the last seven years was Sandy which itself was a bit of a frankenstorm--an extratropical storm running into a nor'easter and arriving in the New York/New Jersey area at high tide, and not just any high tide but the full moon high tide. Fortunately for the bond buyers they hadn't been offered the opportunity before Sandy hit....

So now, after an 11-year run, the RIA's decide hey, ho, let's go.
As the odds of a hurricane-favoring  La Niña setting in just hit 75%.
And yields on cat bonds hit record lows.

See also our thinking in January, after the jump.

From Institutional Investor:

Registered investment advisers are the latest converts to the asset class, which aims to profit by betting against natural disasters 

The low-Yield Investment climate has left registered investment advisers searching for new opportunities to make it rain for their clients. Some believe they’ve found a way — as long as that rain doesn’t come with flooding and gale-force winds. Catastrophe bonds, insurance-linked securities tied to natural disasters, have long been a source of yield for alternative investment firms. Now they’ve made it onto the radar of U.S. wealth managers looking to deliver returns with relatively little risk.

“When clients’ life savings are at stake, cat bonds offer opportunities on several levels,” says Sam Sudame, director of research at SingerXenos Wealth Management, an RIA based in Coral Gables, Florida, that has allocated 5 percent of its $1.2 billion portfolio to the asset class. “By its very nature, a quality cat bond portfolio is diversified and offers powerful return compared to the risk — both crucial for private wealth management.”

Family offices in Europe and in East Asia, especially Japan, have been investing in catastrophe bonds for more than a decade, says John Seo, co-founder of $5 billion Fermat Capital Management, a Westport, Connecticut–based specialist in the paper. Pioneered 20 years ago by Warren Buffett and Allstate Insurance Co. in the wake of Hurricane Andrew, which devastated Florida, catastrophe bonds were the domain of alternative managers at first.

particularly after the 2008–’09 financial crisis, lured by the promise of returns uncorrelated to a weak market. As they seek to shore up lackluster 60-40 portfolios, RIAs are the latest to embrace what Seo jokingly describes as an “unrisky for a risky” asset class.

A catastrophe bond passes on the risk of what insurers call peak perils from reinsurance companies to investors. Actuaries calculate the likelihood of, say, an 8.5 magnitude earthquake hitting Southern California or a Category 5 hurricane battering the Gulf Coast and price the security accordingly.

If the event covered doesn’t occur before the bond matures — the term of the bond is typically three years — the investor can receive a sizable coupon payout, often LIBOR plus a spread of 3 to 20 percentage points. (Given catastrophe bonds’ popularity, yields have dipped in the past couple of years.) If a natural disaster of the magnitude outlined in the prospectus does strike, though, the bond triggers and the premium goes to the sponsoring reinsurer to help cover policyholder claims.

Here’s why catastrophe bonds are risky yet unrisky: Looking beyond their ratings, which are typically in the double-B range, the triggering calamity tends to be unlikely. “With events such as Hurricane Irene and the tsunami in Japan, 2011 was one of the worst years for the reinsurance industry,” notes Canon Hickman, a wealth manager at Henrico, Virginia–based Equity Concepts, whose $700 million in assets include catastrophe bonds. “Yet only four out of some 120 cat bonds were impacted.” In fact, the market edged up that year because those disasters reminded investors of catastrophe bonds’ existence.

Since Zurich-based Swiss Reinsurance Co. began tracking catastrophe bonds in 2002, there hasn’t been a down year: Through 2015 the Swiss Re Cat Bond Index gained an annual average of almost 7.7 percent. Compare that to the jitters sparked by recent geopolitical events such as Brexit, and it’s easy to see why RIAs like an asset class uncorrelated to the equity and fixed-income markets......MORE

January 28, 2016
"Is the re/insurance industry really prepared for a large tail event?"

No.
The plan is to lay any claims over about $50 billion on taxpayers.
That's insured losses not total losses.
Short the re/insurers this year. The probabilities are shifting against them and although it's not a lock it is still the way to bet....