Market Extra: Insurers on the hook for Harvey and Irma could signal end to bond market’s recent rally

Market Extra: Insurers on the hook for Harvey and Irma could signal end to bond market’s recent rally

Investors breathed a sigh of relief after Hurricane Irma shifted course over the weekend and the expected financial toll fell to more tolerable levels. U.S. stocks surged as bond prices slipped, with market participants rotating out of government paper into so-called risky assets on Monday.


Some bondholders feel the worst has passed. But the selloff could continue, pulling the 10-year Treasury note yield TMUBMUSD10Y, +1.44%  further from this year’s lows, which stayed below 2.10% for much of last week.


If insurance firms and reinsurance companies on the hook for the damages from the two hurricanes need to sell their holdings of corporate and government paper to meet claims, it could burn a torrid path across the Treasurys market, some market said participants.


According to Deutsche Bank strategists led by Stephen Sparks, Treasury yields tend to show a modest bump 15 to 20 days after landfall. John Mousseau and Gabriel Hament of Cumberland Advisors found the benchmark 10-year Treasury yield would rise on average more than 13 basis points, or 13 hundredths of a percentage point, after a severe hurricane.


“These hearken to the anecdotal experience that large insured losses could drive some insurers or reinsurers to liquidate assets (presumably largely long duration bondholdings) in order to free funds to service claims,” they wrote.


See: How will the bond market hold up against the one-two punch of Irma and Harvey?


Similar instances were seen in Japan after the earthquakes in 1995 and 2011 stoked speculation that Japanese life insurers sold Treasurys, one of their most liquid assets from abroad, and repatriated the funds to meet their claims, spurring a jump in the USDJPY, -0.02%  yen.


Insurance firms tend to have sizable holdings in long-dated government paper to match their lengthy liabilities. Although some have dipped their toes in dicier parts of the financial markets, like private equity, to juice returns, most keep the bulk of their assets in bonds.


The National Association of Insurance Commissioners calculated U.S. insurance firms kept around $4 trillion, or two-thirds of their portfolio, in bonds in 2016.


But reports from The Wall Street Journal said U.S. insurance firms with business in Florida were not necessarily on the hook. Many of them had shifted the burden of paying damages for meteorological catastrophes to so-called reinsurers, which agree to take on a slice of the risks in return for a premium. Assurant Inc. AIZ, +0.75% said Monday that losses from Hurricane Irma would be covered by its reinsurance program.


“To the extent that this behavior recurs, it could constitute some additional catalyst for upward pressure on rates in the near term, naturally presuming that the Fed’s inflation narrative remains plausible and geopolitical tension does not escalate further,” wrote the Deutsche Bank strategists.


Traders speculated insurance companies were off-loading government paper to intensify Monday’s selloff, where the 10-year Treasury yield lifted off from its 2.10% level to notch its biggest single-day jump in more than seven weeks.

“Insurance companies have probably waded into the market, whether it be in corporate bonds or Treasurys,” said Tom di Galoma, managing director of Treasurys trading, on Monday. “A lot of these reinsurers in Bermuda could possibly be doing some selling, too. That has been the main theory today why the market is cheapening.”


Many of the largest reinsurance firm, s like Partner Re., are non-U. S. entities incorporated in Bermuda, according to A.M. Best, a credits ratings agency specializing in the insurance industry.


But Tom Tucci, managing director of Treasury trading at CIBC World Markets, suggested the selling pressure investors saw at the week’s start was more a reflection of waning geopolitical concern from North Korea and an unwinding of short-term tactical trades


“We’ve had a lot of short-covering in the weekend. A lot of the market just dissipated,” said Tucci, referring to when speculators are forced to buy back a security they had wagered earlier to fall.


And reinsurance companies have ample cash reserves to weather the storms, said Brian Schneider, senior director of Fitch Ratings. Though such companies invest in short-term Treasurys, they wouldn’t need to dip into their holdings of government bonds to meet claims.


Irma’s “a big event, but it’s not as bad as it could have been,” said Schneider.


Irma’s impact was blunted by its sudden turn of direction, but the combined devastation from Irma and Harvey is still expected to reach as high as the $150 to $200 billion, according to a preliminary estimate provided by Moody’s Analytics. And forecasts for total losses incurred by the reinsurance industry in its annual confab at Monte Carlo have displayed a wide range, according to a Reuters report.


With reinsurers unsure of the final bill, they might end up selling a few Treasurys anyhow.