The impact of a ~$40bn catastrophe on ILS portfolios will be less painful today, in real terms, than it would have been five years ago – largely because of work that has been done to manage exposures.
Higher retentions, better rates and more careful risk selection and deal structuring will all play their part in limiting the downside from Hurricane Milton.
On the day after the storm’s landfall, a canvass of sources suggested consensus was building around a $40bn-$50bn loss, putting off the table the worst-case scenarios that would have tested remote-risk ILS strategies.
Some US-based sources were even hopeful that the loss could fall below the $40bn level, which will be further strengthened by some early modelled loss scenarios emerging after the storm.
Florida losses still tend to carry a conservative mark-up by global reinsurers, given the state’s experience with loss creep, notwithstanding the local reforms enacted in recent years to clamp down on litigated claims.
Regardless, with a ~$40bn loss scenario, all segments of the ILS market will benefit from what will be a manageable earnings event, as managers moved after Hurricane Ian to bake in the potential for similar losses without losing money.
Return implications
Low-attaching and quota-share retro and sub-Florida Hurricane Catastrophe Fund reinsurance treaty business will be impacted by claims, though the picture is unclear as to the ultimate outcome on an annual returns basis, given the high premium buffer available to absorb losses.
Major carriers in this category include Advantage, Aeolus and DE Shaw.
Sources noted that retro attachments are now more commonly around $50bn, although there is some coverage in the market kicking in at $35bn or $40bn. Some suggested a few Florida retro triggers at still higher levels these days, particularly for reinsurers that have trimmed their peak peril books.
A further complication in assessing the impact on aggregate covers is that Milton followed closely after Hurricane Helene. Some sources are now discussing potential losses of $10bn-$15bn from Helene, but event deductibles have tightened in recent years, so it remains unclear if this would be enough to trigger second-event covers.
Among mid-layer and more remote risk strategies, impacts are expected to be more easily absorbed, with most of these funds, if not all, still being in positive-returns territory for the year.
Within Florida more broadly, most ILS funds are active, with Nephila and RenRe among the significant players, and investors could have exposure by way of Bermuda sidecars.
Many mid-risk strategies have reduced their exposure to Florida over the last few years, by combinations of writing less Florida business, hedging out risk and writing higher layers.
These strategies may take a hit in the region of 10%, according to one source, which would leave them in positive-returns territory for the year.
Another suggested much of the ILS market would take only a low to mid-single-digit loss from the storm, enabling managers to still deliver high single digit to low-double-digit returns for the year.
This reflects the fact managers have built up significant return buffers already this year – the ILS Advisers Index had racked up a 7.6% return through the end of August, and initial September figures based on partial data had taken this to 9.6%.
In the sidecar segment, there is an expectation there will be some “dents” to profitability.
However, annual returns are still expected to hit mid-teens in the event of a $40bn Milton loss, according to one source with knowledge of the niche.
Cat bond strategies look safest overall, with one firm suggesting modelled loss impacts of 1% or less.
Trapping implications
However, even if the eventual Milton losses have only a minor impact on ILS earnings, significant chunks of ILS capital are likely to be locked up in the short to medium term, given that cedants can buffer up their losses by a factor of as much as 2x in the initial months after an event to hold reinsurance capital.
The ILS market has a significant market share of Florida reinsurance business, which will comprise a major part of the losses, along with commercial E&S losses, to which the ILS market will also have some exposure.
Analysis by Insurance Insider ILS of ceded reinsurance premiums from top Florida insurers suggests the ILS market has around a 20% market share of the state reinsurance segment.
A large part of this capital will be deployed at high risk/return periods that should be more likely to remain clear of trapping, even at a $40bn loss.
But a simple calculation of the ILS market’s potential share of the loss, starting from this 20% market share and adjusting downwards, ranges from $3bn-$10bn, based on a $30bn-$50bn industry loss range.
Factoring this up for buffered loss calculations suggests trapped capital could reach $6bn to $20bn, or 6% to 18% of the total estimated $110bn market.
However, this will overstate the risk of trapping, given the ILS market’s skew to remote risk levels.
There are around $5bn of cat bonds on risk for Florida domestics, and while it is not possible to rule out loss implications for those transactions, setting this aside would reduce the trapping implications to as low as $1bn up to $15bn.
For some high-risk deals, capital trapping could be confined within premium levels, making renewal negotiations somewhat easier.
But even at a lower industry-loss level, sources said the implications of the storm have put a stop to discussions of cat rate reductions in 2025.
Outlook
While there may be short-term impacts from capital trapping, the event, due to Milton’s Sarasota swing, will be a routine one to handle for the ILS industry.
At the upper end of loss forecasts, the scenario would have changed dramatically.
A loss event at $50bn-$70bn would have seen losses “mount more quickly”, a source said.
Another noted that, at $70bn-$80bn, “cat bonds start attaching; everything is in play”.
This year could still be strong for the market, even if not as strong as last year, when the ILS Advisers Index showed a 14% gain, and many made 20%+ returns.
The questions in the weeks ahead will now revolve around the rate and capital reaction to the storm.