We have discussed insurance linked securities (such as “Catastrophe Bonds”) for a few years while clients have held mutual funds investing in such securities. As a reminder, owners of these securities receive the returns and assume the risk of selling essentially very high “deductible” natural disaster insurance to reinsurance companies (which in turn sell insurance to insurance companies). Reinsurance has been a good business for a long time and provides returns unrelated to the returns from financial assets.
The last few years have been unusually benign with respect to the occurrence of significant natural disasters in areas with large amounts of insured property value. Earlier this month, that looked likely to change as then category 4 Hurricane Matthew moved toward southeast Florida. In the end, tragic as it was for Haiti and in flooding in the Carolinas, this weather event did not prove to be material for the insurance linked security market. When the worst looked likely, prices adjusted downward and most funds holding diversified insurance linked securities fell 2-5%, but those declines were quickly reversed.
Acceptable returns are not earned without the assumption of risk. There will come a day in which these funds experience losses for a given year. That may still occur this year, but if it does, it will not be because of Matthew.