Damian Cilmi: Welcome listeners to another installment of the Premium Investment Leaders Podcast. I'm your host, Damian Cilmi, Head of Investment Managers at Governance at Premium, one of Australia's largest specialist investment platforms. Our aim is to provide our listeners with insights from investment managers from around the globe and today is no different.

Today we're heading into the world of catastrophe bonds. Whilst many might be unfamiliar with this asset class, it's been operating as a tradable market for over 20 years, has its own index, and valued at over 100 billion. Many pension endowment funds have been attracted to this space for its uncorrelated returns.

And about our guest today, we're really excited to speak to a real thought leader in this space who's been featured in articles by Michael Lewis. As many will know and also testified before U. S. Congress on the catastrophe bond market. Dr. John Seo has been active in insurance linked securities market for over 25 years.

Prior to forming Fermat with his brother, Nelson in 2001, Dr. Seo was a senior trader in insurance products at Lehman's as a state appointed advisor to the Florida Hurricane Catastrophe Fund. And about Fermat Capital, founded in 2001 in Connecticut. Fermat is a specialist catastrophe bond investment manager and provides investment management services, pension funds, sovereign wealth funds, endowments, and private investors from around the globe.

Employing over 40 staff, the firm manages over US $10 billion. John, welcome to the show. 

John Seo: All right. Very nice to be here, Damian.

Damian Cilmi: And we're really excited to get into this space. I've been wanting to do this one for a couple of years. I'm just waiting for, for, for the time for someone to come out because this, this is a space that, you know, we see it around, especially in Australia all the super funds have to list their investments.

And we could see a couple of line items around catastrophe bonds. There's a few investors around in private wealth, but I don't think that many people really know too much about it. So let's start from the, from the start. So what is a catastrophe bond? 

John Seo: A catastrophe, but it's a bond like any other bond.

It's got a fixed maturity in this case, typically three years, sometimes five years. So it's relatively short dated and it pays you a coupon for your money, right? And these days that coupon in us dollars is something around 15%, one five. So very high rate of return. It's a floating rate instrument.

So it's actually indexed again in US dollars, roughly to a one month T bill plus 10%. That's how you get the 15. So it's got no interest rate risk. It's paying a very high return, short, a short duration, you know really the, the question is what's the catch, you know? And, and hence the name, you know, we, we didn't want to name these 100 percent safe bonds or victory bonds.

You know, we want to, Disclose the fact that you're getting paid a lot because you are exposed to a risk. A risk such as Miami being destroyed by a hurricane. Or Los Angeles 

being destroyed by a earthquake 

Damian Cilmi: Sure, and and so that's I was going to ask about what types of events are covered you touched on some of those.

John Seo: Yes 

Damian Cilmi: Are they just as a single event in the bond or is there multiple events covered in the one bond? 

John Seo: Yeah, I was simplifying of course, but The vast majority of the bonds are, can be, the risk can be stated that way, largely, that you need a major metropolitan area severely damaged or completely destroyed by a natural catastrophe to cause a significant loss of the portfolio.

You could, you could also get a very minor loss from a, a large wildfire.

Damian Cilmi: Sure. 

John Seo: But, you know, that, that might actually cause, say, like a half percent loss to the portfolio, et cetera. So a lot of people, when they, they quiz about the risks of these bonds, they're like, that's it? That's it? Why are we being paid?

Really, in the end, you're getting paid this tremendous sum because the insurance industry is trying to cover for an event. that would take the entire insurance 

industry down.

Damian Cilmi: So, so let's get into the lock. So who were those issuers? And maybe let's go through the layers of, you know, what, what an insurance, I suppose, event, how it's covered.

John Seo: Right. Sure. So the, 

the, the the issuers of these cat bonds, we technically call them sponsors. But those who are seeking this coverage are really the largest insurance companies. re insurance companies, re insurance being insurance companies for insurance companies. Yes. They have that level of protection.

As well as governments. There are a lot of governmental agencies. Anybody that you might say the buck stops with them. Sure. In terms of the risk. They're the ones that are holding this risk that just can't be hedged or diversified away. There's a lot of pressure on them to do so. You can see it indirectly in the headlines in the US.

You might see that the insurance market that the leading insurers are just canceling policies That they're doing that because they're actually over risk of it. Yeah, it's actually it's not about how much they're being paid And then what they do unfortunately is in order to get people to drop their insurance They they hit them with a 

sky high bill that they can't pay 

Damian Cilmi: because we've been hearing some stories about that I think especially in the the southeast Down around Florida in particular that insurance premiums really gone through the roof.

Haven't they? 

John Seo: Yeah, that's interesting You mentioned that because say in California, you can't get the coverage at any price. Okay, so they they just jacked the price In Florida where the cap, it's sort of the cradle of the cat bond market. Because the cat bond market is servicing Florida so strongly, even though the premiums are dear, they're high, the coverage is available.

You know, and so it's sort of like the cup is half full 

there in Florida for the consumer. 

Damian Cilmi: And maybe just from an Australian perspective, is there any cap bonds out on Australian based risk? 

John Seo: Let's 

see here, at the current moment, on and off we do have that. We do have a bond that covers New Zealand, the earthquake authority out there.

So certainly we do touch this part of the world. Normally the traditional reinsurance market covers Australia and New Zealand typically no problem so to speak. So we're really, the catastrophe bonds are there. Just for those, mainly for those risks that simply can't be borne in the size that they're available, right?

So the insurance companies know how to rate these risks. That's not the issue. It's just the, the, the bet size, the size that they're betting. It's just too big. They're just not allowed to take on that much risk. 

Damian Cilmi: So let's go into, I suppose, the regulatory capital for an insurance company. Can you go us through the layers and how they end up in this space?

John Seo: Sure. So the capital required for an insurance company overall is similar to what you would see in banking, but it's much more dramatic. And it's dramatic in this sense. Insurance companies, when they are within their risk limits, they look like casinos, well run casinos, right? Like I love the movie Ocean's 11, right?

So it's like it's like, it's the, it's the, the picture of a very well run casino, right? That's not being attacked by George Clooney and but so they they're very well run. And what, when they're well run that way, everything just goes like clockwork. Everything's all good. What messes up a casino is the equivalent of they get carried away and a big whale walks in and they let them bet a hundred billion dollars on a single hand of blackjack or something like that.

Right? So you can imagine that can wreck casino. So that's what's the pressure on these insurance companies. And what the regulator does is that they monitor for that. And they put a draconian capital charge for it. So you actually can see it in the movie Ocean's Eleven a little bit. Because the central premise of the movie is that they must have cash in the vault for every dollar of chip that they've got out on the floor.

Think about that. It's the odds of losing all the chips that you have out on your floor. are astronomically small, right? Everything's all risk managed. And yet the Nevada Gaming Commission in Ocean's Eleven wanted a hard U. S. dollar in the vault for every notional of chip out on the floor, which sets up a robbery risk.

Right? So what you see here is that the, in a sense, the regulator and insurance says, I don't care how astronomical the odds are. If there's a one in a trillion chance that That you could lose this much money from a Miami hurricane. I want you to have cold hard cash and an insurance That's that's equity capital very expensive So really it's not meant to be realistic for that to occur The the let's call it the gaming Commission doesn't want you accepting hundred billion dollar bets Sure, it's meant to be a penalty an incentive to get that risk off your books hook or crook And hence we get paid this, this fabulous 

premium.

Damian Cilmi: Yeah, there you go. I had no idea we were going to be talking about Ocean's 11 today. So there you go. But I really enjoy the analogy. That's that's good. So let's go and talk about the market structure. So now we know what they are and who the issuers are. Actually before we get in that, like, so how are the contracts held?

What do they look like, the actual contracts themselves? Are they isolated away, are they, are they, I'm going to use the word secure, but you know, what are the rights then for, for both parties? 

John Seo: So for the catastrophe bond, it's, it's a fascinating structure. What we do is that we, for each bond, we actually create a brand new insurance company to mediate that risk.

This is a huge issue in the old days in that it used to be that it was just very difficult to get a cat deal done. Because you would have one of the largest insurance companies in the world, or a government. You know our U. S. federal government actually issues catastrophe bonds, right? So I actually helped them set that up.

It's a very awkward situation because, you know, it's my brother and I in a windowless office facing off against the U. S. Government, and it's like, who are you? You know, I don't even, you know, I don't know who the so brothers are. But I said, Look, it's no problem. This is this is how it works. We form an insurance company to be in between you and me, between the federal government and myself.

That insurance company makes the promise to pay you, the government. say 500 million if there's a big flood. I said, okay where's that 500 million come? I go, that entity, that insurance company issues 500 million in catastrophe bonds, right? And they take the proceeds of that bond issuance and they put it into a T bills that, that made the federal government feel better already.

Yes. They're like, well, that's money. Good. Of course. It's exactly. And it's just held in trust. By this, this new insurance company that's chartered only right this one contract. So it's got no legacy issues, etc. And that's it. So I'd likened it in in one of my congressional Testimonies to a giant baseball cap.

I said just picture that you've got two people. I just saw a footy game yesterday So I'll say you're at a footy game and for whatever reason two friends want the one Want to bet an ungodly amount of money on the outcome of the game, right? So there's usually a third person sitting in the middle. They take their cap off and both of you put your money in the cap.

You're both friends, but it's a lot of money. So at the outcome of the game, the person in the middle will hand the money over to the winner. Right. So, this cap on structure, the special purpose insurance company, is like a giant baseball cap with a hundred billion dollars in it. And that way, that the government, and by the way, we ourselves too, don't have to worry about counterparty credit risk, right?

Because in the old days, what they would say is like, I don't know you and your brother, so I tell you what, you put the hundred million dollars up front and you just put it in our bank account. Well, now I'm exposed to your credit risk, right?

Damian Cilmi: And other activities that you're doing. 

John Seo: Yeah, exactly, which we don't want.

We want this purely focused. If Miami's destroyed, there's an objective way to measure that. Then fine, the money is yours, right? Other than that, I don't want exposure to anything else that you're doing. The solution is to create a brand new insurance company. That's what revolutionized our market. It allowed a complete insensitivity to counterparty credit risk.

Damian Cilmi: So now we have a very clean and identifiable contract and structure here. So, you know, let's, let's go and talk about the market, size of the market, you know, the liquidity as its own index as well too, doesn't it? 

John Seo: That's right. You can punch it up in 

Bloomberg. Yeah. If you type a Swiss it'll, the Bloomberg usually knows what you're talking about and says, Oh, you mean the Swiss recap on index.

Yeah. And it's fun. You can, you can play with that the index run correlation versus any assets that you please. It's really nice. It's been in the, in the machine for, since 2002. So we have our own index. It's a hundred billion dollar market, you know roughly half of that is a liquid and tradable.

Yes. And and it's a lot of fun. Every trade hits the Bloomberg in 15 minutes. So, even if you're just starting out, You can actually start following the trades. You can, you can see how it trades. 

Damian Cilmi: And so just in terms of its liquidity as well, I don't maybe by way of example of, of what you're doing on a daily basis.

I mean, there's primary and then there'd be secondary liquidity as well too. So how much a secondary liquidity is out there? How, how frequent are you out there? 

John Seo: It's significant. I mean, we, there's trades that we're doing every day. And so there's a significant amount of the trade. Now, most people are satisfied with their, their purchase, right?

Investors they buy a bond. It's got a 15 percent coupon, very transparent risk. You know, the nice thing about the market is that there's no leverage involved. So I used to do fixed income arbitrage in markets that at times in aggregate were leveraged 30 to 50 times. Well, you've got a market that's, that's running massive leverage.

So people get very jumpy, you know, you call up Goldman Sachs and ask them for the bid and the dealer, you know Just runs to the bathroom and just says I'll be back to you Comes back the bids 20 points lower because they don't know are you unwinding all that leverage? They can't tell yeah, it's beautiful here It's very pure Really?

The only question is when somebody's looking for a bid or looking to buy something is is there is there earthquake occurring right now? Is there a hurricane in the water? It's relatively transparent. Yeah, right So the, the market trades quite freely, which is very nice as opposed to, as I say, other high yield, highly leveraged type of markets.

And so it's really just people, you know, raising cash because they need it for whatever reason, or people putting cash to work 

for whatever reason. 

Damian Cilmi: So how will you value in a bond? Let's start at a primary. And so what are the factors that you're looking at to say that is acceptable risk that that's an acceptable yield.

We will take this. 

John Seo: Absolutely. So a bond comes to market. Let's let's give an example here. We had two bonds recently. Very, very different. But in the end, after we cranked the science, and the science is actually just a simulation of earthquakes and hurricanes. Yep. So, you know, we have very good earthquake records.

You know, every year we record over 600, 000 earthquakes. Yep. And there's a, there's a way to actually dig trenches in the ground and earthquake zones and actually see all the ancient earthquakes that have occurred. They leave scars in the ground. It's like counting rings in a tree. So you can, you can publish a record going back 5, 000 years, 50, 000 years.

And very similarly, believe it or not, for for hurricanes too. When they come on shore, they push so much sand up. And it literally leaves, leaves a ring in the ground as it subsides. Yeah, they carbon dated, et cetera. So we actually know the odds. And what we know is that these phenomena are surprisingly stable over, over thousands of years.

The real risk is that whether the earthquake hits Los Angeles or San Francisco, or whether the hur the hurricane hits Miami, Or Houston or Manhattan, right? And fortunately, these, these phenomena don't care where we built the cities. They're just kind of doing their thing, releasing energy. And so what we do is that we look at the science and we look at the location of the exposure of the bond that's given in a very transparent way.

And so really we see what are the what's the probability, not that just a large earthquake or hurricane occur. By the way, those each. occur roughly 24 times a year, somewhere on the face of the earth. So they're actually relatively common occurrences on the face of the earth. You just got to hit a trillion dollar concentration of insured property.

So we'll calculate those odds and we'll get a number like 1%. And in the example I'm about to give here, we got a number like 3%. There's a 3 percent probability that this bond will be impaired or blown entirely by earthquake or hurricane. Okay. And we make sure that sometimes there are minor errors in the design of the bond.

They're not intentional, I should say, which is nice. If they were intentional, I'd be really mad. But so they're not intentional. And sometimes that number might be in the prospectus as 3%. But we rated at four or five. But we make the adjustment and we see what premium that we're being paid, right? And there you go into a different mode.

Because there's, there's roughly 330 cat bonds out there at any given time. Available in the primary or in the secondary market. So once you've vetted the risk and made all the adjustments that you need to make, you look at what premium you're being paid. It's usually attractive, but is it as attractive as something else that you might be able to get?

So the example I'm about to follow through here, Is that believe it or not, this actually happened. There was one bond that was paying at 18. 5 percent coupon spread. So treasuries plus it was near 24 percent coupon, 3 percent expected loss. But then near simultaneous with that was another bond that was paying a 6 percent coupon spread.

One third of the amount of that other bond I was talking about. And it, and why? Well, supply and demand. For some reason, the investors, not ourselves, were so in love with that bond that they made it six times oversubscribed. So naturally, the issue responded by lowering the yield, seeing when people would drop out.

Well, when they lowered the yield, it just made the people 

that were bidding for it even crazier, you 

know. 

Damian Cilmi: So why were they so attracted to that one? Was it like an uncommon risk that they didn't have in their portfolio? And was that a reason? 

John Seo: This is a super interesting question. The one that was paying well was Louisiana only.

Yeah. And I don't know what it is about investors. They just look down on Louisiana. Okay. 

Damian Cilmi: Sorry to all the listeners from Louisiana. 

John Seo: If I want Cajun food, I'll go to Louisiana. But, you know, for a bond, no. Although this bond program's been around forever. So it's not a new, new The other one was plain vanilla.

You know, I'll use an analogy. It's like one bond. was like like a stock on a on a mid cap pharma company. Got it. Yeah. And the other bond was like a an option on the S and P 500. Yeah. It was broad. And and I liked those deals. They're fine. All things being equal, but investors had gotten in their mind that you want to be on those index bonds, ones that are just covered to all 50 States.

Earthquake and hurricane, and they just got too carried away, and they got, they got caught up in the fervor of, you know, the lower the yield went, the higher the orders in the book went, you know, the orders are supposed to go down, not go up, but they just got carried away, and it got very, very frothy, and naturally we didn't invest in that deal, and that was really kind of a little mini bubble.

So you do the science, but after that it's, it's a market, right? And you, and of course what you're trying to do is avoid the fads and the trends and buy things perhaps that are at the moment a bit unfashionable. 

Damian Cilmi: Other than relative value analysis of, I suppose, what you just talked about just before, is there any anything else that will kind of change some of your fundamental value day to day when you're looking at things and saying, okay, Now we're a little bit more interested in this year, you know, what, what, what are the, I suppose, revisions going on each day?

John Seo: Right. So what's happening is that these yields are flying around, by the way, that bond that was obviously too rich in our point of view. Dramatically by the dealer that brought the bond to market within a month, they marked the bond down on the price. Yeah. It's the ultimate validation. Our view. It's like, that's just crazy.

It's just a bubble. So they dropped the bid on one of the tranches to 89 and there's still no buyers interested there. Okay, so what's and that's a dramatic example, but in miniature that's going on every single day People are getting in their heads that they find This type of bond attractive and when they get in that mode, they bid it up and they're not so price sensitive And vice versa, they'll actually think this bond's out of favor.

I'll sell it So what we're doing is simply reacting to that that, that, that risk reward. There are times where we will come up with a surprising piece of research that tells us that a bond is much riskier than we had thought it was. And interestingly, we'll actually come up with a view that a bond is significantly, significantly less risky than we, when he thought it was.

And then of course, naturally we update the view, like much that I described there, look at relative value, reweight the portfolio. 

Damian Cilmi: Yeah. I mean, we could go into, you know, so much of the maths all behind it as well and and your team, I'd be very curious for another time, but we'll keep on going talking about I suppose some portfolio applications and what you see out of this.

And naturally you're a specialist in your space, but where you see it being utilized within portfolios and some of the motivations for people to include it. And then we'll get into some other applications as well too. 

John Seo: Well, as you had mentioned earlier, you know, in the very early days you know, the phone calls that we receive, by the way, for a good 10 years, you couldn't sell this product.

You don't just call up somebody out of the blue, cold call them and say like, hey, I'd like to sell you a catastrophe box. I tried it, by the way. They hang up the phone in five minutes, if they're polite. So you have to wait for them to do their research. Find out the asset class exists and then find out who are the handful of players.

that actually specialize in it. Right. So it's pretty simple. You wait for the phone to ring. And in the early days they were calling because they said, well, look, the spreads look attractive. We'll see after we do our diligence, if that's still, we still believe that. But of course it's kind of a no brainer.

A market crash can't cause an earthquake or hurricane to occur. So you're, you have this fundamental non correlation that it's just terribly attractive. And so they're saying if, if these, these spreads, you know, a lot of them in their heads, they would just haircut them in half. They'd say, okay, it's got a 10 percent spread, you know, yield spread.

I'll just make that 5 percent because there's going to be slippage, et cetera. But no matter how much they haircut them, if the story was legit, it deserved a very significant place in the portfolio, right? Cause portfolio optimization, if it finds a brand new risk that actually has a decent. you know, excess spread.

The math says by a lot of it, right? So that was the primary motivation. What we're seeing now is very interesting. People just outright attracted to the absolute returns. So this is a little bit of boasting, but I'm just reporting what our clients are telling us. 

Many are telling us that 

last year this asset class was the best performing period.

Just across all strategies in the portfolio. So the absolute returns are just, you know, are very attractive. And that's what I've always told people. I said, look, if your motivation is that you want to diversify your portfolio in a very fundamental way, a way that lets you sleep at night, again, market crash, can't cause an earthquake or hurricane.

So you're good. That's fine. But I would sell this asset class on its absolute return as well. 

Damian Cilmi: All right. Yeah. Now, so let's get into that. Like what, what, what happened last year? So I suppose you've got base. Rate effect as well, but I'm sure it's a hell of a lot more than that as well. So what was the major drivers, I suppose, in a repricing last year?

John Seo: Right? So you're talking about, so T-bills, you know, was high in the US Yeah. You know, 5% plus off zero. Yeah. We shouldn't take credit for that. Yeah. Right. But the spread over that 10%. mm-Hmm. . Right. So, and and to give you a feel for that, if you look at the default rate that we're getting from estimating.

the frequency of occurrence of these earthquakes and hurricanes. It looks kind of like a a double B, single B type of credit risk. It's not a credit risk, right? But you can look up the credit risk default tables and you say, okay, if you just want to look at pure probability of losing some of your principal, that's what it looks like, right?

So our spreads are double or triple comparable credit. Although again, it's not a credit risk. Why is it so generous? Why is it paying so well? And that's because really there's a lot of reasons for it. But if I had to use one word, it's inflation. Okay, so what inflation has done is it's made it 30 percent more expensive to replace the building that we're sitting in right now versus pre pandemic here, right?

So, just picture that you have roughly 500 billion dollars sorry, yeah, 500 billion dollars. I always have to be careful, billion, million, trillion. There's 500 billion dollars of catastrophe reinsurance that covers the market. That's what keeps it glued together, keeps it moving forward, right? So, if you increase the exposure, literally the cost of repair, By 30 percent you need a hundred and fifty billion more of catastrophe reinsurance, right?

Okay, and that believe it or not in my world. That's a lot, right? That's larger than the size of the insurance link securities market the cat on market itself which is an absolute necessity for the market to function. So that's a tremendous uptick in a very short period of time of the need for reinsurance.

Now here's the kicker. Have you heard of something called Silicon Valley Bank? Yes. Right? Okay, good. So, asset liability mismatch. They went long, you know, government bonds, and it didn't work out well for them. Turns out the reinsurers did the same thing. So when the interest rates spiked from this inflation, their balance sheets got killed.

So at the very moment when the reinsurers are being called on to provide $150 billion more of catastrophe reinsurance, they their ability to do that actually shrunk. Shrunk by roughly 100 billion. So that, that mismatch in demand for this catastrophe coverage that cap bonds provide, Is what's powering our market to historic highs.

Damian Cilmi: And I suppose another element of it is that I suppose the size of the insured risk keeps on growing as well too. So you kind of see this kind of natural growth. 

John Seo: Thank you. Exactly. So I just talked about just inflation, right? Just materials of labor. Oh, gosh. But even if you had zero inflation, the growth of this market here is significantly greater than GDP.

And the reason is rather subtle, you know. Yes, we keep making office spaces and homes, right? But what we do is that when we make a new unit of housing, a new unit of office space, We tend to put it right next to a fairly crowded area, right? We don't just put it out in the countryside where no one wants to be.

So it's really not just amount of exposure. It's the, the density, the concentration of that, that drives this risk, right? It's just too many eggs in the, in the same basket. That effect is very powerful. It's been going on for virtually a century. And what we have confidence in is that it's going to go on for another century, even with work from home and so on and so forth.

So yes, you're right. The exposure to human created exposure is growing quite rapidly. I keep talking about the great Miami hurricane, well I did earlier, right? So that's a scenario analysis. So you just, you just say a category five goes right through the heart of Miami. It will look like an atomic bomb blast took out Miami, right?

And we know all the buildings and all the condos. We know the square footage, square meters of space, the cost of construction. So there's a very clinical calculation about how much it'll cost insurance companies. When I first started in the late 1990s. That scenario analysis was a 35 billion loss for insurance companies.

That number is now 250 billion on its way to 500 billion. The same scenario, right? So that's a rapid increase. 

Damian Cilmi: To give an indication to the listeners of the world, what's like the population growth been over that period as well? 

John Seo: Oh, that's a really good question. Let me see here. The population growth. over the last 20 years.

Damian Cilmi: Yeah, down in that corner would have been quite significant as well. 

John Seo: I should know that. I don't have the answer. It's very significant, of course. Yeah, because let me try to do that number there. It's probably grown by a roughly. Eight million people. Yeah, it's kind of it's I Should know that number. 

Damian Cilmi: No, no, that's fine.

John Seo: Yeah, but I think it's just yeah It's so high that it's confusing when you state it It's sort of like the equivalent of Kansas and Tennessee and so on so forth is moving to Florida every year, right? But if it's not Florida, it's actually the coastline. Okay, and the or areas even on the interior where there's just a lot of natural catastrophe risk.

That's what makes the U. S. unusual. People like to live where there's the maximum danger.

Damian Cilmi: I think that's a topic for another podcast right there, too, I'll pick that one. Talking about catastrophes, I suppose, in that space let's go through a bit of a worked example of, you know, when, when an event does occur.

You know probably 22, there was a, there was a few events. 

John Seo: Ah, yes. So we had Hurricane Ian, I think is what you're referring to, in the U. S. and it struck Florida. A pretty big concentration of property. Yeah. So that was, that was a, that's actually technically our most dramatic event in the 25 years.

Yeah. A history of the Cat Bond market. Mm. It's, it, it's hurricane Katrina comes really close. Yes. Which happened, you know, almost 20 years ago. Yeah. So this is kind of a one in 20 year type of occurrence in our marketplace. And it was a big one. It was a $50 billion insured loss from that hurricane.

And what happened to the portfolio? Right. So on a mark to market basis, unfortunately it made landfall on Wednesday. September 28th and Friday's month end. And there was a, there was another little detail. All the market makers were off at this big industry event in Germany, October. And so they were all hung over and just flying back to, to man the desk after this hurricane in mainland landfall.

And they're, they're calling us up and say, where's the market? What's going on? They have to price 300 bonds. By Friday, you know and the thing and the hurricane mean landfall on Wednesday. So the marks were were quite low and What they would do is they took a typical cap on portfolio down from anywhere from six to ten percent Hmm, so that's the mark to market loss two days after Hurricane Ian depending on the portfolio six to eight percent down So, of course we immediately delivered that news To our investors frankly, they took it.

Well that the headlines were so dramatic. They were expecting that number to be much larger 

Yeah, 

he says that's all I say. Well, it's just that that's the number that's what it's down But what it turns out and we knew at the time is that that that that mark to market loss was overdone 

Damian Cilmi: Yeah, right I was going to ask you about that about the estimation bit of a your stuff versus what the markets thinking in that event as Well to imagine these opportunities 

John Seo: Yeah, absolutely.

So a lot like options markets, as you know, you can look at the price of an option and calculate the implied volatility, right? So very simple technique. And then of course you compare that to actual vol. If there's a big enough difference, you know, there's an opportunity. So here at the pricing, the way it plunged, the implied loss from Ian to insurance companies was roughly 80 billion.

Now our estimate was turned out to be roughly 50 billion. Okay. So and the number actually turns out to be about that. So like 48. 4 billion by current, current count. So the market baked in that. And as I say, it's a people business in the end. I mean, you have a bunch of hungover, you know, market makers who really weren't following it and they were off having a good time and they just didn't expect this hurricane.

So yeah, it was, it was overbaked and, you know, we continue to sharpen our pencil and look at every single bond position to to see if there was anything that was under baked, you know, that that can happen. So it's, it's, it's frankly a lot of fun. I know it sounds like stress, you know, but we, we really love this because in a sense we as a team prepare for the, have been preparing for these moments for 25 years.

Yeah. You know, this is what we live and breathe and you're really testing your knowledge. You know, in these types of events, you can't just read the papers to figure out what's going on. It's not a good idea. I'm not trying to denigrate journalism or anything like that, but it's just, you know, they're, they're reporting on the drama, not on the numbers.

That's not what they do. So it's our job to figure out those numbers. Now it turned out that in the end, of course there was a loss. This is a very significant hurricane, but the principal loss ends up being roughly 3 percent on a Cat Bond portfolio. So that's money you kiss goodbye. And that's going to actually repair homes, et cetera.

That's it. What it was intended to do. Exactly, it was do it. Now, the premiums though, on a go for basis, skyrocket in our market. So, you're making back that loss you know, within half a year or so. And that's a pretty typical recovery. So really the whole key here is to go in knowing, and there's full disclosure, it's a catastrophe bond, right?

So you will take some losses, you know. But if you don't panic. And you let your manager do their thing the recovery is actually surprisingly 

Damian Cilmi: quick. Yeah. And it does I'm just hearing so many similarities with, with high yield credit, which is around workouts and expected losses as well. Yes. And relative value assessments here.

John Seo: That's right. 

Damian Cilmi: So, it's, it's, I think again, And I'm really glad that you were able to explain so many of these things because it sounded, you know, to many people like an uncommon, unfamiliar market. But when you boil it all down, it's insurance contracts, it's expected losses. That's right. You've got workouts out of it.

John Seo: And it's, it's All those things are familiar. Exactly. It's physical damage. You know, you say, where does that estimate of 50 billion come from, by the way? What it is, is that we looked at a database, so this is, in the end, it's public information. It's not public information, it's very costly because you want to pay people to clean the data.

The raw data is public. But, you know, if you want to be professional about it, you clean it up. So we buy a lot of, and clean a lot of data ourselves. The data said that if you took the sum total of all the buildings in the footprint of Hurricane Ian, And you did the technical replacement cost. How much would it be cost cost to rebuild all those buildings?

Number was roughly 500 billion us, you know, and given the intensity and the type of the hurricane we knew that the damage would be roughly 10 percent of that exposure. That's, it's called a mean damage ratio. So, so it's, it's, it's physical reality, right? You're not trying to figure out. You know, whether, you know the players in the market are going to deleverage or start, you know, selling out of their of their positions and therefore push prices down.

You really are just looking at cold, hard reality to see what the effect would be. And sure, as I described, the market can overshoot, but really it just creates opportunities for you, right, to buy or sell. And everything resolves out pretty quickly. But the analogies to high yield are actually good. You know, I told you already that you can actually treat this as having an equivalent credit rating because it's Walt rate of double B, single B.

Because of this reality, it turns out it was an odd thing that happened to us recently. We got an award. And the reason why it surprised us, usually when you get an award there's a lot of handling beforehand. It's like, oh, would you like to buy some advertising in our ? Go? So that's what I swear we, you know, we, you know, we didn't pay for it, you know, it, it was a, it was an award for fixed income and the category itself was actually high yield, which really surprised me.

Right? So my, my brother was kind of in the, in the vicinity and they, they actually found him. would you like to come by to the award ceremony and get your award? And it was for high yield. It wasn't for cap bonds. And that's, that's a first. Now what's interesting is that in that category were all these other high yield funds, but also cap on funds.

So analysts now are comfortable with thinking this as kind of like an alternative high yield. Yeah. 

Damian Cilmi: They're very interesting. So just on the, the the, You know, final question about Outlook and kind of what investors are talking about at the moment. So you're out here in Australia. So what are some of the questions?

How are they feeling about this market? And I suppose what's your, what's your, what's your comfort for the next, you know, 12 months or so? Right, 

John Seo: right. Well, there's two questions that we typically get is one is, is the party over? I already described to you that last year was kind of a party, a yield party, a huge cap.

the amount of risk capital globally to absorb this new demand for reinsurance purely from, from inflation. Right. So, okay. So it was very attractive. And the, the people are wondering, is it, is it too late to get a piece of that? And my answer is no, you know, cause that 150 billion gap hasn't been healed over, not even close.

And, and so we're seeing that in our yields, it's virtually the same as last year. So that's the first question. And the second question is. There are a lot of reports of a ultra active hurricane season that, that's coming up. And that naturally gives investors some pause. By the way, I'll, I'll point out that effectively they've been calling for extraordinary activity in the U.

S. Hurricane market since two thousand and six. So it's almost a perennial yeah, exactly. And the reason is very simple. The water is very hot. The ocean is very hot. That's, that's absolutely true. And so they naturally just conclude that that should give you more, more hurricanes, more energetic hurricanes.

And I want to give you an analogy and, and, and it's absolutely not true. That's the thing that, that hurricane phenomena is actually very complex. It it, and, and beautiful, frankly, you know it's, it's an interesting way for the earth to actually react to the difference in temperature at the equator and at the poles, right?

Mm-Hmm. , they're very, very different. And as well as temperature difference between the surface of the earth. And way up high to the stratosphere. Right? So those temperature differentials drive all these interesting phenomena. But, it's a, it's a complex phenomena. And I want to relate it a little bit to the, to the AFL football game.

I think you call it footy. You're doing well for all the Melbourne 

Damian Cilmi: listeners here. 

John Seo: Okay, this is my first time yesterday. I saw it at the, at the hallowed, you know Melbourne cricket grounds. Yeah. My first time, I've always wanted to see it. Which is just behind your shoulder, by the way, too. And it was, oh, that's, okay, so we're nearby.

And it was, I was really surprised at how beautiful the game was and how fluid it was and everybody's going all around. And it was, you know Melbourne, unfortunately, didn't have a very good No, they didn't. No, absolutely. I guess. But it's always, when you look at sports and performance, there's Moneyball, et cetera.

Yeah. This is what they're doing on Hurricane. They're saying. What if we gave every player an extra ration of three meat pies before every game? Yeah, that's more caloric input. That's more energy for them and energy should get you more points, right? But anybody that knows the sport wouldn't expect that if you force three meat pies on every player Right before they stepped out on the pitch that they're gonna score extra points from the extra energy, right?

It might actually go the other way. It might make them more sluggish. That was the word I was going to use. I used three meat pies because I ate three meat pies. It was also something that I couldn't help myself with. They were so good. So, I used that analogy because there was a paper that was just released out of Stanford University and a very good group of researchers that essentially said that they realized that because we've been observing the fact that when the water's really hot It actually doesn't result necessarily in more hurricanes.

Sometimes it's less and more energetic hurricanes. And because the scientists didn't know why, they just kind of shrug their shoulders. It turns out that the humidity that's created from that extra heat literally makes the hurricane more sluggish. 

Damian Cilmi: Yeah, okay. Very interesting. I love the analogy. And so it's 

John Seo: like, yeah, it's just like forcing three meat pies on every player and thinking it's like, okay, they should run a little bit faster, be a little bit more energetic.

It doesn't work that way. And, you know, and if everybody knew how to make these footy players score more points, they'd be doing it. It's very difficult. They're at their peak. Maximum performance and these these natural phenomena are much the same way And when you inject more heat or more temperature in a very simplistic way, it doesn't it doesn't 

Damian Cilmi: result in more results John, unfortunately, we have to leave it there, but I would love to have you back again another time talk up more AFL and About the catastrophe bomb market.

Thank you It was a great primer for for everyone out there and we'd love to get into more detail. So thanks again 

John Seo: Damian, thank you. Thanks.

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