Catastrophe bonds when catastrophe strikes

Summary

Marketplace Morning Report: "Catastrophe Bonds When Catastrophe Strikes"
Release Date: January 15, 2025
Host: David Brancaccio
Produced by: Marketplace

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Overview

In this episode of Marketplace Morning Report, hosted by David Brancaccio, the focus pivots between innovative financial instruments designed to mitigate disaster impacts and the escalating homelessness crisis exacerbated by the ongoing Southern California wildfires. The episode delves deep into the mechanics and market dynamics of catastrophe bonds while also shedding light on the human and societal ramifications of natural disasters intensified by climate change.

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Understanding Catastrophe Bonds

Amy Scott opens the discussion by highlighting the burgeoning market for catastrophe (CAT) bonds. "Market has been booming with a new high of more than $17 billion in bonds issued last year and average returns of around 14%" (00:46) she reports, indicating strong investor interest and robust performance in recent years.

Chris Grimes, a specialist tracking the CAT bond market at Fitch Ratings, elaborates on their operational framework. "The way catastrophe bonds work, an insurance company only gets the money if a specific type of catastrophe happens and losses exceed a certain threshold" (00:56). He further explains, "Money back plus interest" (01:17) to investors if the trigger conditions aren't met, ensuring a safety net for both insurers and investors.

Despite the prevalence of disasters in 2024—including winter storms, flooding, and hurricanes—Grimes notes, "The types of risks that are insured by CAT bonds tend to be fairly risk remote, meaning that a very large event typically would need to happen to trigger losses to investors" (01:36). This cautious approach ensures that only significant, aggregate losses activate payouts, thereby maintaining market stability.

Robert Hartwig, a professor of finance, risk management, and insurance at the University of South Carolina, provides a broader perspective on the global landscape of CAT bonds. He states, "Of the $50 billion in catastrophe bonds outstanding globally, approximately 12% of that has exposure to wildfires" (01:58). Hartwig emphasizes that many of these bonds cover multiple peril events and rely on aggregate loss thresholds, suggesting that simultaneous severe events—like tornadoes and hurricanes—could collectively trigger payouts (02:09).

However, Hartwig warns of shifting market sentiments: "CAT bonds trade in a secondary market and prices there have dipped for some bonds, suggesting investors do expect some losses" (02:23). This dip reflects a growing anticipation of more frequent or severe disasters, potentially influenced by climate change.

Carolyn Kuski from the Environmental Defense Fund underscores the dual-edged nature of CAT bonds. While they can "help stabilize the troubled property insurance market by spreading risk from insurance companies to investors like pension funds and hedge funds" (02:53), she cautions that increasing risk may lead to higher costs. "It's likely to get more expensive as risks continue to increase from climate changes, then it's not going to really help us with affordability problems" (02:53). Kuski emphasizes the need for "hard decisions about who should bear the cost of climate risk and dramatic investment to reduce it" (03:03), pointing to systemic challenges in balancing financial mechanisms with social equity.

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Homelessness Crisis Amid Southern California Wildfires

Transitioning from financial instruments to social impacts, the episode addresses the dire situation in Southern California, where ongoing wildfires have destroyed approximately 12,000 homes, significantly aggravating the homelessness crisis.

Sabri Benishour engages in a conversation with Alex Vysotsky, Senior California Policy Fellow at the National Alliance to End Homelessness. When asked about managing homelessness before the fires, Vysotsky reveals, "We've got 75,000 people experiencing homelessness in LA county on any given night, and 70% of those folks are outside" (04:39). Despite efforts to house over 20,000 individuals annually, the "unaffordability of our housing market" continues to drive more people into homelessness (05:06).

The recent wildfires introduce additional pressures. Vysotsky acknowledges, "You have twin challenges now where the housing market is going to be even more competitive" (05:16). The destruction of homes not only displaces more individuals but also strains the already limited shelter capacities. With "only 30% of folks experiencing homelessness are in shelters, 70% of folks are outside" (05:43), natural disasters like wildfires complicate access to safe spaces and essential resources.

As fires persist and air quality deteriorates, the need for comprehensive disaster planning becomes paramount. Vysotsky advocates for "unprecedented coordination between local government, state government and federal government to ensure that we're getting more resources available to get folks to safety" (06:37). This includes advocating for "rush funding" to augment efforts in providing immediate shelter and long-term housing solutions (06:37).

Vysotsky underscores the systemic nature of the crisis, emphasizing that "folks experiencing homelessness are the last to be thought of" during disaster responses. This gap highlights the necessity for inclusive planning that prioritizes vulnerable populations, ensuring they are integrated into disaster preparedness and response strategies.

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Takeaways and Future Outlook

David Brancaccio wraps up the episode by touching on the broader economic indicators, such as the upcoming Consumer Price Index reading. However, the core of the episode remains anchored in the intricate interplay between financial mechanisms like catastrophe bonds and their role in addressing both economic and societal challenges posed by climate-induced disasters.

The episode serves as a comprehensive exploration of how innovative financial tools are being leveraged to manage disaster risks while simultaneously highlighting the pressing human cost exemplified by the homelessness crisis in wildfire-impacted regions. It calls for a balanced approach that not only harnesses financial innovation but also ensures robust social support systems to navigate the multifaceted challenges of an increasingly volatile climate landscape.

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Notable Quotes:

• Amy Scott (00:46): "Market has been booming with a new high of more than $17 billion in bonds issued last year and average returns of around 14%."

• Chris Grimes (00:56): "The way catastrophe bonds work, an insurance company only gets the money if a specific type of catastrophe happens and losses exceed a certain threshold."

• Robert Hartwig (01:58): "Of the $50 billion in catastrophe bonds outstanding globally, approximately 12% of that has exposure to wildfires."

• Carolyn Kuski (02:53): "It's likely to get more expensive as risks continue to increase from climate changes, then it's not going to really help us with affordability problems."

• Alex Vysotsky (05:16): "You have twin challenges now where the housing market is going to be even more competitive."

• Alex Vysotsky (06:37): "We're advocating for HUD and Congress to work together to make what's called rush funding available."

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This episode of Marketplace Morning Report offers a nuanced understanding of how financial innovations intersect with real-world crises, urging listeners to consider both economic instruments and human-centered solutions in addressing the multifaceted challenges posed by climate change and natural disasters.

Transcript

[David Brancaccio]

The role of catastrophe bonds in paying to rebuild after fires and other disasters. I'm David Brancaccio. In Southern California. Officials say about 88,000 people remain under orders to stay away from their homes given the fires still burning and especially high winds in the forecast today. A UCLA study finds fossil fuel driven climate change is contributing to these fires being hotter and larger and a teachable moment now on what are called catastrophe bonds, financial instruments issued by insurance and reinsurance firms and sometimes governments to help cover losses in a disaster. They help keep insurance markets functioning at a time when it's harder for homeowners to get coverage. Marketplace's Amy Scott reports the catastrophe bond.

[Amy Scott]

Market has been booming with a new high of more than $17 billion in bonds issued last year and average returns of around 14%.

[Chris Grimes]

Yes, investors have done fairly well over the last couple of years.

[Amy Scott]

Chris Grimes follows the CAT bond market at Fitch Ratings. He says the way catastrophe bonds work, an insurance company only gets the money if a specific type of catastrophe happens and losses exceed a certain threshold. If that doesn't happen, investors get their.

[Chris Grimes]

Money back plus interest.

[Amy Scott]

And though there were plenty of disasters in 2024, winter storms, flooding, hurricanes, the.

[Chris Grimes]

Types of risks that are insured by CAT bonds tend to be fairly risk remote, meaning that a very large event typically would need to happen to trigger losses to investors.

[Amy Scott]

A large event like the LA fires? Not necessarily. Robert Hartwig is a professor of finance, risk management and insurance at the University of South Carolina. He says of the $50 billion in catastrophe bonds outstanding globally, approximately 12% of.

[Robert Hartwig]

That has exposure to wildfires.

[Amy Scott]

And a lot of that is in bonds that cover multiple perils that are only triggered if aggregate losses reach a certain amount. But Hartwig points out it's still early in the year.

[Robert Hartwig]

And so if we have a severe tornado season and if we have a severe hurricane season at some point, it's possible that the aggregation across all these events will trigger payout on the bond after they're issued.

[Amy Scott]

CAT bonds trade in a secondary market and Hartwig says prices there have dipped for some bonds, suggesting investors do expect some losses. Carolyn Kuski researches climate risk management at Environmental Defense Fund. She says CAT bonds can help stabilize the troubled property insurance market by spreading risk from insurance companies to investors like pension funds and hedge funds. But if investors lose money, they'll likely charge more to take the risk as.

[Carolyn Kuski]

It'S likely to get more expensive as risks continue to increase from climate changes, then it's not going to really help us with affordability problems.

[Amy Scott]

She says that's Going to take some hard decisions about who should bear the cost of climate risk and dramatic investment to reduce it. I'm Amy Scott for Marketplace.

[Kai Ryssdal]

Hey, it's Kai. My minivan and I, as I've said on the radio, have logged a lot of miles with Marketplace. Luckily, it's still running, you know, pretty well. But if your car doesn't drive as well as it used to, listen up. It can still help drive Marketplace. When you donate your old car or truck. We'll use the proceeds to support the great programs you hear every day. Start your vehicle [e-mail] vehicle more than.

[David Brancaccio]

12,000 businesses, schools, houses of worship, but mainly homes, have been destroyed, and the Southern California fire is still burning. Newly homeless put pressure on an already strained system of housing. This includes the 75,000 people who were all already unhoused before the fires. My colleague Sabri Benishour spoke with Alex Vysotsky. He's Senior California Policy Fellow at the national alliance to End Homelessness.

[Sabri Benishour]

Can you give us an idea of how Los Angeles was managing the homelessness crisis before the fires?

[Alex Vysotsky]

We've got 75,000 people experiencing homelessness in LA county on any given night, and 70% of those folks are outside. Los Angeles is doing more and more to address this crisis. The LA houses over 20,000 people each year, but because of the unaffordability of our housing market, folks are falling into homelessness at too fast a rate for us to really drive those numbers of people experiencing homelessness down.

[Sabri Benishour]

Well, I mean, now we've got on top of that a situation where people with homes are seeing those homes destroyed. Does that mean we're going to see more people unhoused?

[Alex Vysotsky]

It might. Right? You have twin challenges now where the housing market is going to be even more competitive. And we know that that can drive more folks into homelessness and drive costs up. We also know that for folks that are currently unhoused, it's going to become all the more competitive and all the more challenging to get back into housing.

[Sabri Benishour]

Yeah, and for the folks who are unhoused right now, I mean, how have the fires affected them?

[Alex Vysotsky]

So, you know, in Los Angeles, only 30% of folks experiencing homelessness are in shelters, 70% of folks are outside. So that becomes even more challenging now when existing shelters are at risk. And then, you know, I think there's always challenges with disaster response. Folks experiencing homelessness are the last to be thought of. Right. When you have wildfires or other disasters, the guidance can be, you know, stay inside or, you know, keep your cell phone charged. So that you can get up to date alerts. So one of the things that Los Angeles and other regions need to look at is how do we make sure folks experiencing homelessness become kind of central to disaster planning and a key component of disaster planning.

[Sabri Benishour]

And this is, of course, ongoing. What can we expect in the coming days? As, you know, unhoused people continue to face the fires and air quality situation.

[Alex Vysotsky]

I think in the days ahead, what we're going to need to see and what I hope we'll see is just an unprecedented coordination between local government, state government and federal government to ensure that we're getting more resources available to get folks to safety. Here at the national alliance, that means we're advocating for HUD and Congress to work together to make what's called rush funding available. That's funding that can augment and assist with efforts to get folks into shelter and get folks into housing.

[Sabri Benishour]

Alex Vysotsky is the Senior California Policy Fellow at the national alliance to End Homelessness. Thank you, Alex, so much.

[Alex Vysotsky]

Thanks so much, sir.

[David Brancaccio]

B We're waiting for a key reading on inflation this morning. The Consumer Price Index is supposed to hold steady November to December. David I'm David Brancaccio. Marketplace Morning Report from apm, American Public Media.

[Rob]

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