LONDON (Reuters) – Investors in niche financial bonds that cover insurers against huge natural disasters are on alert for future events that could force them to pay out after the powerful tornado that struck the U.S. on Monday, brokers and fund managers said.
Catastrophe bonds are used by the insurance industry to transfer financial risks of extreme events like earthquakes or hurricanes, to investors, who receive an annual return in exchange for agreeing to cover damages they consider very unlikely..
There are six bonds which cover around $1 billion of tornado risk in the United States. These bonds were sold by Chubb , Country Mutual and North Carolina Farm Bureau, and the United Services Automobile Association (USAA).
According to fund managers assessing the tornado that hit the U.S. state Oklahoma on Tuesday, cat bond investors are unlikely to have to foot a share of the bill because the total cost of damage won’t be high enough to trigger a payout.
But as weather forecasters predicted more storms for the U.S. Midwest, volumes of futures insurance claims could increase and bondholders could end up sharing some of the losses.
All six transactions that cover U.S. tornado risk are structured as “aggregate” bonds, meaning the bond will trigger a payout if the insurer accumulates a pre-agreed amount of loss over a specific time frame.
Cat bonds are designed to cover natural catastrophes that are so big they only happen once every 250 years.
The events typically need to hit specific locations at a specific intensity to trigger a payout and these pre-agreed amounts can often run to several billions of dollars before investors are called to share the losses.
James Vickers, chairman, international at insurance broker Willis Re said it was too early to draw conclusions on the total insured loss for the Oklahoma twister.
But losses from Monday’s tornado, combined with those from other natural disasters in the near future, may play a part in triggering a payout on one of the bonds, he said.
A similar tornado hit the Midwestern towns of Joplin and Tuscaloosa in 2011, wiping out a $100 million cat bond called Mariah Re, which was issued in 2010 to cover severe thunderstorm losses for American Family Mutual Insurance..