Australian superannuation funds are assessing the potential impact of the Los Angeles wildfires on their exposures to catastrophe bonds and other insurance-linked securities.
Following years of stellar performance, interest among super funds has been growing in an asset class that offers diversification benefits from a return stream uncorrelated to other markets.
And even though the brunt of losses from the LA wildfires are expected to be borne by primary insurers and high-risk reinsurance program, super funds are closely monitoring the possible impact of estimated insurance losses of as much as $US30 billion ($48 billion).
Colonial First State chief investment officer Jonathan Armitage told Investment Magazine that CFS recently made an allocation to natural catastrophe risks of between 1 per cent and 2 per cent of its diversified suite of funds.
Armitage said this exposure is “spread across various insurance-linked strategies including catastrophe bonds, quota shares and direct reinsurance”.
“The allocation is heavily diversified across geographics and perils, with a focus on loss-remote – low-risk – reinsurance, given attractive pricing dynamics and the secular thematic of climate change,” he said.
Armitage said CFS’s exposure to US wildfire risk, which is perceived as more susceptible than some other catastrophe risks to the effects of climate change, “constitutes a relatively small portion of the portfolio”.
“While our exposure to the LA wildfires is limited, we are monitoring the impact of these events and flow-through impact to the reinsurance market closely,” he said.
“At this stage it is too early to assess the extent of the impact as the situation is still evolving. However, initial industry insured loss estimates range between US$10 billion and US$30 billion, with the majority of losses expected to be absorbed by primary insurers and higher-risk reinsurance programs.”
JANA Investment Advisers senior consultant Martin Rea says Australian super funds are exposed to catastrophe bond and insurance-linked securities and most have “investments in the more liquid cat bond market but there are a few with more private ILS holdings”.
“Not everyone, but interest has been growing,” Rea says.
Future Fund was reported in October last year to have about US$1.5 billion ($2.4 billion) invested with specialist ILS managers as at 30 June 2024, down from about US$2.6 billion at 30 June 2022, and US$1.9 billion as at 30 June 2023.
The $92 billion REST Super said the fund has between $200 and $250 million invested in insurance-linked securities as part of its alternatives exposure, “a relatively small part of our overall FUM”. The fund declined to comment on the impact of the LA fires on its holdings.
HESTA, AMP, Aware and Cbus said that they have no exposures to catastrophe bonds. AustralianSuper, UniSuper and Hostplus declined to comment.
Rea said the attraction to super funds of cat bonds and other insurance-linked strategies is due to the so-called “hard market” in insurance, which has supported cat bond yields.
“The last two years of the hard market have been positive for cat bond investors with the Swiss Re Cat Bond Index returning 19.69 per cent in 2023 and 17.29 per cent in 2024,” Rea said.
At the same time, the catastrophe bond market has not been affected by the increased frequency and severity of natural disasters to the extent that might be expected because the “attachment point” – which is the insured-loss threshold that must be exceeded before cat bond holders are required to pay – has increased over time to compensate.
“For example, when Hurricane Ian hit in 2022, the cat bond market fell by around 9 to 10 per cent,” he says.
“If that same hurricane hit now, given the higher attachment points, some managers believe it would result in a [roughly] 2 per cent loss.”
Rea said JANA is “not expecting a significant impact to investors holding cat bonds and other ILS funds”.
“Moreover, the eventual impact is softened somewhat by the outsized return generated by the ILS market in the last two years,” he says.
Rea said, at the time of speaking to Investment Magazine, an estimated 12,000 structures had been impacted by the LA fires, and the total economic impact is expected to be much higher than the insured loss estimates.
He said the situation in LA remains very fluid, and the outlook and ultimate impact can change quickly. The full impact may not be known for many months.
“It is important to note that the insurance market in California has been in distress due to higher risk awareness by [insurers and reinsurers] and regulatory dysfunction,” he said.
“Many insurers have cut or stopped wildfire coverage due to the increased risk and state regulations preventing them from raising premiums.
“Many ILS managers have also avoided taking on wildfire risk within their portfolios as the risk-return profile is not compelling.”