How Hedge Funds Are Preparing For This Weekend’s “Catastrophe”

Friday, September 8, 2017
By Paul Martin

by Tyler Durden
ZeroHedge.com
Sep 8, 2017

This weekend Hurricane Irma is set to unleash hell over Florida, resulting in devastation and damages worth tens of billions of dollars… and many hedge funds are on the hook ahead of their own coming balance sheet “catastrophe.”

On Wednesday we reported that as a result of the imminent destruction to befall Florida, investors in catastrophe bonds – among them prominently one Stone Ridge Capital – could be facing a total wipeout on their investments (those unfamiliar with (Cat)astrophe bonds and Insurance-LInked Securities are urged to read the original article, especially since this will be a very prominent topic in the weeks to come). As a quick reminder, as their name suggests, catastrophe, or cat, bonds are a bet (by the buyer) that a catastrophic event such as a hurricane won’t take place, instead allowing them to clip 3 years work of generous coupons and get principal repayment at maturity; they are also a bet (or insurance) by the seller that a catastrophic event will take place, in which case the bonds contractually default, and as much as the entire principal amount could be forgiven.

In short, cat bonds are a form of securitized “reinsurance”, sold to hedge funds, catastrophe-oriented funds, and various other return-starved “alternative” asset managers and offer diversification as they are uncorrelated with other risks such as equity market risk, interest rate risk, and credit risk.

It will probably not come as a surprise to anyone, that the firm behind catastrophe bonds is, drumroll, Goldman Sachs:

Michael Millette, the former head of structured finance at Goldman Sachs Group Inc., helped the bank develop a market for cat bonds in the 1990s. It was one of the first signals that high finance had discovered the reinsurance market. Millette now runs his own fund, with backing from Blackstone, according to Artemis, a trade publication.

Cat bonds are also largely untested, especially at a time when two “100-year storms” are set to hit the US within 2 weeks of each other.

“The market for this kind of thing is pretty untested,” said Ryan Tunis, an analyst at Credit Suisse Group AG. “There are questions of how fast they’ll pay out, whether they’ll pay out” he added quoted by Bloomberg.

The cat-bond market is currently valued at almost $90 billion, and almost half is tied to risks in Florida, where insurers are mostly state-run entities and small regional carriers looking to mitigate risk. “For the most part, the cat bonds have remained resilient. Part of this is due to a lack of major disasters in the biggest U.S. cities, where losses would be large.”

As Bloomberg writes, cat bonds began to proliferate in the wake of Hurricane Andrew, a disaster so devastating that the World Meterological Organization discontinued the use of the name after the 1992 hurricane season, according to Swiss Re AG. Significant losses from California’s Northridge earthquake in 1994 and the Kobe temblor in Japan a year later motivated many companies to find reinsurance, or insurance that backs insurance.

The Rest…HERE

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