Hurricane Otis likely to trigger Mexico catastrophe bond payout

The Government of Mexico’s catastrophe bond is facing its most severe threat of the current Pacific tropical cyclone season, as hurricane Otis has rapidly intensified to a category 5 storm and its central pressure has deepened sufficiently to trigger the $125 million IBRD / FONDEN 2020 tranche of notes that are exposed.

In recent weeks, this specific tranche of catastrophe bond notes that were issued with the help of the World Bank to provide disaster insurance protection to Mexico has come under threat before, after hurricane Lidia made landfall earlier this month with a central pressure that was close to the threshold for the parametric trigger.

But now, hurricane Otis looks like a much more severe threat and based on the reported pressure at landfall, it appears hurricane Otis will trigger the Fonden cat bond notes, causing a loss of principal to investors holding them.

Recall that the Mexican governments World Bank IBRD issued $485 million IBRD / FONDEN 2020 catastrophe bond provides disaster insurance protection against both earthquakes and hurricanes, all on a parametric trigger basis.

In particular, a $125 million Class D tranche of notes provide parametric insurance protection against Pacific hurricane events.

The parametric trigger for the cat bond’s Pacific hurricane coverage is based on landfall location and minimum central pressure of any storm that approaches the Mexican coast.

In order for the $125 million Class D Fonden 2020 cat bond notes to face any loss of principal at all, the minimum central pressure of hurricane Lidia would need to fall to 935 mb or below.

Hurricane Otis is reported to have had a minimum central pressure of 923 mb at landfall, with sustained winds of a devastating potential at 165 mph.

The NHC explained, “Maximum sustained winds are near 165 mph (270 km/h) with higher gusts. Otis is a category 5 hurricane on the Saffir-Simpson Hurricane Wind Scale. Otis is forecast to remain a category 5 hurricane through landfall. Rapid weakening is then expected once Otis moves inland over the higher terrain of Mexico. Otis will
likely dissipate over southern Mexico on Wednesday night.”

Otis’ central pressure deepened by over 50 mb in just 12 hours, the latest example of a rapid intensification for a hurricane nearing landfall.

At the time of this update, in making landfall hurricane Otis has crossed the parametric trigger threshold line that runs along the Pacific coast of Mexico.

Landfall is in the Acapulco area, a tourist region and one of relatively high coastal population, so having intensified rapidly to category 5, the threat to lives and property is significant.

At 923 mb, hurricane Otis is likely to trigger Mexico’s catastrophe bond and cause a 25% or even a 50% loss of the $125 million of exposed principal, it now appears.

The parametric trigger for the World Bank’s Fonden cat bond sees a coloured line drawn along the Mexico coast and it is the minimum central pressure a hurricane has, as well as where its center breaches that line, that defines the payout amount, which can be 25%, 50% or 100% of the principal outstanding, so $125 million for the Class D Pacific hurricane notes.

Because of the way the parametric trigger is constructed and the fact we don’t have the exact data, in terms of geographic locations and pressure to derive the trigger amount, it is difficult to be certain whether hurricane Otis will cause a 25% or 50% of principal triggering event at this time.

We also need to consider the fact that the final determination can need to wait for the so-called “best track” data from the NHC’s tropical cyclone report, which can take weeks to be delivered.

However, in this case, as hurricane Otis was deemed to be well inside the parametric trigger central pressure parameter, a 25% loss of the $125 million of principal looks extremely likely, while a 50% or more payout could be on the cards, depending on the final determination.

We’ll update you should any certainty emerge over the coming days, but these Class D Fonden 2022 catastrophe bond notes are almost certain to trade lower today on a loss appearing likely.

Given hurricane Otis had sustained winds of 165 mph at landfall it is a particularly dangerous storm and so this is precisely the scenario that catastrophe bonds are designed to provide payouts for, offering a source of disaster risk financing to aid in reconstruction and recovery from natural catastrophe events.

You can read all about the $485 million IBRD / FONDEN 2020 catastrophe bond and every other cat bond transaction in the Artemis Deal Directory.