Recent estimates suggest that insured losses from the Los Angeles, California wildfires could be higher than anticipated. As a result, catastrophe bond prices are showing signs of weakness, with the market’s benchmark recording its first-ever negative January return since its inception over two decades ago, according to cat bond fund manager Icosa Investments AG.
With a performance of approximately -1% for January 2025, this marks the twelfth-worst monthly return on record the cat bond market has ever seen.
As we reported last week, reinsurance firm RenaissanceRe is basing its estimate from the wildfires on a $50 billion industry loss event, while global re/insurer Chubb also seems to be working from a relatively high industry figure too.
Industry loss estimates from catastrophe risk modellers for the LA region of California wildfires so far have a mid-point average of $31.125 billion.
The range, across now the four leading catastrophe risk modelling firms, spans from $20 billion to as high as $45 billion.
“Since many cat bond sponsors have yet to disclose their loss expectations for the LA wildfires, it remains uncertain whether further losses should be expected or if the market will recover in the coming weeks,” commented Icosa Investments.
The firm continued: “This downturn should come as no surprise. At Icosa, we repeatedly warned that the market’s muted pricing reaction to Hurricanes Helene and Milton left it in a state of “pricing for perfection”, particularly for aggregate bonds. Any hopes for such perfection in 2025 are certainly gone now. Regardless of the ultimate wildfire losses, it is already clear that attachment erosion will remain a key concern at least until summer 2025.”
It’s important to note that many of the potentially affected cat bonds are indemnity aggregate structures, which also cover tornadoes and other severe convective storms.
Because of this, a high degree of uncertainty may continue to persist until these bonds go through the 2025 tornado season in the second quarter and reach their resets in summer, Icosa Investments warns.
As we’ve been reporting, a number of catastrophe bonds have recently seen further negative secondary market price movements due to potential exposure to aggregate attachment erosion, or actual losses, from the wildfires.
According to our recent article on the cat bond price movements seen, the implied write-down, in mark-to-market terms from the wildfires, stood at around $200 million. Which shows that the cat bond market could only shoulder a small proportion of the losses that flow to reinsurance capital.
As well as annual aggregate cat bonds, some occurrence structures are also exposed to the wildfires.
“This is not the start to 2025 that many cat bond investors had hoped for, but it should not come as a surprise. Unlike the market overreactions seen after Hurricanes Irma in 2017 and Ian in 2022, when cat bond prices dropped far more than justified by fundamental losses, we have been critical of the market’s lack of reaction following Hurricanes Helene and Milton in 2024,” commented Florian Steiger, CEO of Icosa Investments AG.
He continues: “While uncertainty remains (in both directions), with loss reports from many cedants on the LA wildfires still outstanding, I would not be surprised if there is more downside ahead for these bonds in the case of an active tornado season.”
Steiger also added that it will be interesting to see how private insurance-linked securities (ILS) markets adapt, noting that historically private ILS has required “near-perfect conditions” to generate returns without running into collateral trapping.
“For contracts exposed to wildfires, it is already reasonable to say, just a few weeks into the year, that 2025 will not provide such conditions. Investors in these less liquid structures should be prepared for a repeat of well-known challenges like collateral trapping and sidepocketing, at least as a possibility,” Steiger concludes.
Read all of our coverage related to the Los Angeles, California wildfires here.
