Selloff's Odd Profile; Hurricane Michael vs. Funds

Summary

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WSJ Your Money Briefing

Episode: Selloff's Odd Profile; Hurricane Michael vs. Funds
Date: October 11, 2018
Host: J.R. Whalen, The Wall Street Journal
Guest: Jeff Rogo, WSJ Global Investing Editor

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Episode Overview

This episode of Your Money Briefing centers on two timely financial stories:

1. The unusual characteristics of the major stock market selloff on October 10, 2018
2. The financial risks posed by Hurricane Michael not just to homes and businesses, but also to large investors such as pension funds and endowments—particularly through exposure to catastrophe (CAT) bonds.

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Key Discussion Points & Insights

1. Odd Market Selloff (00:36–02:56)

• Unexpected Market Behavior:
  The Dow Jones Industrial Average dropped 831 points (10/10/18), marking the Nasdaq’s biggest drop since Brexit in 2016.
  • “Financial markets overall did not exhibit a classic flight to safety.” (J.R. Whalen, 00:53)
  • Traditionally in a selloff, assets like gold and bonds rise as investors seek safety, but this time both were flat.
• Underlying Worries:
  • Rising treasury yields and a trillion-dollar federal budget deficit contributed to investor anxiety about heightened market volatility.
  • Slowly rising inflation and interest rates were also flagged as ongoing concerns.

Notable Quote

“Heard on the Street points to the weakness of treasury bonds and rising yields as sending a shiver down investors' spines.”
— J.R. Whalen (01:01)

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2. 401(k) Loan Defaults and Retirement Savings (01:39–02:38)

• Deloitte Analysis:
  • Defaults on 401(k) loans could result in a reduction of about $210 billion in U.S. retirement accounts over time.
  • “Leakage” most often happens when employees change jobs and cash out their accounts, incurring taxes and penalties.
  • The projected future loss is 2.7% of the current $7.8 trillion in 401(k)-style plans.
• Cascading Impact:
  • While annual loan defaults amount to $7.3 billion, many people withdraw more to cover taxes and penalties, worsening the impact.

Notable Quote

“The annual impact is far greater given that many borrowers… withdraw additional money to cover the taxes and early withdrawal penalties.”
— J.R. Whalen (02:31)

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3. Hurricane Michael & Pension Fund Risks: Catastrophe Bonds Explained (02:56–07:07)

What Are Catastrophe Bonds? (03:00–03:44)

• Definition:
  • CAT bonds are financial instruments that let insurance companies transfer some disaster risk to investors (pension funds, endowments).
• How They Work:
  • Investors buy CAT bonds and collect higher returns—unless a major disaster occurs, in which case they must pay out.
  • Payouts are triggered once losses from a disaster cross pre-set thresholds.

Notable Quotes

“You lose a lot of that return if there's a disaster. That's the risk you're running as a pension or an endowment. But if nothing happens, you have this wonderful return and it’s a good place to put your money.”
— Jeff Rogo (03:52)

“In some sense, it’s a bet against climate change and a lot of big changes in our environment.”
— Jeff Rogo (04:10)

Recent Performance and Changing Risks (03:44–04:36)

• Returns & Risks:
  • CAT bonds can yield 5–7%, attractive when global interest rates are low.
  • 2017 was a bad year for CAT bonds, and 2018 was shaping up similarly.
• Emerging Trends:
  • Some CAT bonds now cover flooding risks (not just wind damage), reflecting increasing environmental vulnerabilities.
  • First flood-related CAT bonds were issued this year.

Storms and Insurance Market Changes (04:36–06:59)

• Structural Changes:
  • Post-Hurricane Andrew, buildings have stronger wind resistance, but flooding risk has increased due to urban development.
  • Insurance company exposure to Florida has shifted dramatically since the 1990s and 2000s due to severe storms.
    • Major national insurers left the Florida market, replaced by around 50 smaller, lesser-known insurers.
• Regulatory Landscape:
  • Insurance is regulated at the state level, requiring insurers to comply with each state’s requirements.
  • Florida responded with its own insurance entities and robust reinsurance markets.
• Testing the System:
  • Last year’s (2017) series of storms was a major test, and Florida's insurance system held up. Hurricane Michael is another test.

Notable Quotes

“Most of Florida is now insured by a bunch of companies you've never heard of. Whereas if I’m in... New Jersey... we’ve got Allstate and State Farm... In Florida, they aren’t.”
— Jeff Rogo (05:59)

“Insurers don’t go to some federal board... they’ve got to go to each individual state.”
— Jeff Rogo (06:24)

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4. Closing Thoughts

• The episode provides a clear look into how market behaviors and natural disasters can ripple into the broader financial system—including the risks taken by investors via complex products like catastrophe bonds.
• Listeners come away with an understanding of how hurricanes and regulatory structures shape not just property insurance but also the investment environment for pensions and endowments.

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Timestamps of Important Segments

• Market selloff analysis: 00:36–02:38
• 401(k) ‘leakage’ and defaults: 01:39–02:38
• Catastrophe bonds & Hurricane Michael: 02:56–07:07
  • Definition/Explanation: 03:00–03:44
  • Returns & risks: 03:44–04:36
  • Shifting risks and flood CAT bonds: 04:36–05:49
  • Small insurers in Florida: 05:49–06:59

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Memorable Moments

• Jeff Rogo’s candid summary:

  “In some sense, it’s a bet against climate change and a lot of big changes in our environment.” (04:10)

• Insight into the current insurance market in Florida:

  “Most of Florida is now insured by a bunch of companies you've never heard of.” (05:59)

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Tone & Style

• Informative, with a focus on demystifying complex financial concepts for a broad audience.
• The discussion maintains a cautious, analytical tone, balancing explanations of risk with real-world implications.

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This summary skips all advertising and sponsorship content, focusing strictly on the episode's main discussions and insights.

Transcript

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[J.R. Whalen]

With your money briefing. I'm J.R. whelan at the Wall Street Journal in New York. In addition to homes and businesses, pension funds and large investors could take a financial hit as a result of Hurricane Michael. We'll explain why in a moment. First, these money and market stories you should know the Wall Street Journal heard on the street team says that Wednesday's 831point sell off and by the Dow Jones industrials and the Nasdaq's biggest drop since Brexit in 2016 had an odd and peculiar feel to it. Namely, financial markets overall did not exhibit a classic flight to safety. Two safe assets, specifically gold and bonds, were essentially flat on Wednesday. Heard on the street points to the weakness of treasury bonds and rising yields as sending a shiver down investors spines. And it says a trillion dollar federal budget deficit along with slowly rising inflation and and interest rates on the move upward could bring more volatility to Wall Street. And analysis by Deloitte Consulting indicates annual defaults on loans taken against investors 401ks threatens to reduce the wealth in US retirement accounts by about $210 billion when the lost savings are compounded over employees careers. The numbers highlight the problem of tapping 401 savings before retirement, which is known in the industry as leakage. And most leakage occurs because about 30 to 40% of people leaving jobs elect to cash out their accounts and pay taxes or penalties rather than leave the money or transfer it to another 401k or an individual retirement account. The projected future loss amounts to about 2.7% of the $7.8 trillion currently in 401k style retirement accounts. And while 401k loan defaults currently amount to about $7.3 billion a year, the annual the impact is far greater given that many borrowers in default withdraw additional money to cover the taxes and early withdrawal penalties they owe on their outstanding balances. As Hurricane Michael batters the Florida Panhandle, homes and businesses are bracing for the worst. But so are pension funds, endowments and other large investors. And and Wall Street Journal Global Investing Editor Jeff Rogo is here with details. So, Jeff, this has a lot to do with investors ownership and catastrophe bonds that in many cases have exposure to Florida.

[Jeff Rogo]

Yeah, it's A great point, J.R. in Florida, you have this situation where you have a lot of catastrophe bonds. Catastrophe bonds are used by insurance companies to pool the risk of a disaster. So if a disaster hits, an insurance company is on the hook to pay for that disaster. They've pushed some of that risk off into a catastrophe bo, which is purchased by a pension fund, by an endowment. They pay into this CAT bond. If there's a big catastrophe and it goes to a certain level of payouts, they've got to put a bunch of money in. If this causes $20 billion and $25 billion worth of damage, that could mean these investors are on the hook to put money into this and their returns will be lower as a result.

[J.R. Whalen]

These CAT bonds have been an attractive investment for some because they offer diversification, but also a higher return.

[Jeff Rogo]

Yeah, absolutely. We've had rates since the financial crisis. Global interest rates have been near zero around the world. Catastrophe bonds can pay out 5, 6, 7%. You lose a lot of that return if there's a disaster. That's the risk you're running as a pension or an endowment. But if nothing happens, you have this wonderful return and it's a good place to put your money. You can put $200 million in, you're getting these natural returns, but then you lose big if there's a disaster like this, in some sense, it's a bet against climate change and a lot of big changes in our environment. But last year was a terrible year for catastrophe bonds. This year's not looking great and it will be interesting to see what that demand is going forward.

[J.R. Whalen]

You know, for many years, the insurers focused on wind damage, but now flooding is typically so severe that the government issued flood related CAT bonds for the first time this year.

[Jeff Rogo]

Yeah, if you think about just the way that things are built. So after Hurricane Andrew two decades ago, wind was the major culprit in that storm. Buildings weren't built as well and we didn't have the buildup in, you know, that you see in the ground with concrete that makes water sort of run off. You also didn't have as much coastal development that could be hit by storm surge. Now you do, you do have that building more along the water. You do have concrete making it more difficult for water to get away. You do have better built buildings that are more able to take on wind damage. And so now Storm surge and ocean water is a much bigger risk. And because of that, insurance companies, which are very granular, there's a big difference. If your home gets hit by a hurricane, an earthquake, a tornado, a fire, you're smoking in bed. All of these things are a different payout for an insurance company. So it really matters what's taking a home down, because in your contract, you're paying very different payouts for very different things.

[J.R. Whalen]

And the exposure to Florida, at least among many large home insurers, diminished starting in the 90s and the early 2000s after a series of severe storms.

[Jeff Rogo]

Yeah. Most of Florida is now insured by a bunch of companies you've never heard of. Whereas if I'm in, I live in New Jersey and we've got Allstate and State Farm and a bunch of other firms that I can go to, those are dominating the marketplace in most of the country. In Florida, they aren't. It's like 50 tiny companies you've never heard of because a bunch of them just got crushed. The thing that I think people need to step back when they look at insurance that's fascinating about it is insurance is statewide regulated. So insurers don't go to some federal board and figure out whether they're going to do some policy across the country. They've got to go to each individual state and say, can we do this for large insurance companies. They felt that Florida didn't have their back, and so they pushed out. Florida, because of that, had to create its own insurance company, both for flooding and wind. It's had to create a reinsurance market. It's had to entice a bunch of other startups to get into the business. Last year was a huge test for Florida, and it seemed to do okay. You had Harvey, Irma and the other storms. It did okay. This will be another test and we'll see what happens.

[J.R. Whalen]

And that's Wall Street Journal global investing editor Jeff Rogo joining us here in our studio. Jeff, thanks for being with us.

[Jeff Rogo]

Thank you for having me.

[J.R. Whalen]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[Narrator/Announcer]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. [e-mail] WashingtonWise.