Before the Atlantic hurricane season begins each year, forecasters release activity predictions that can have some influence on reinsurance pricing. However, a recent commentary from global alternative and active investment manager Man Group challenges the accuracy of these forecasts, questioning both their reliability and the benchmarks used to measure success.
In the firm’s latest commentary, written by Andre Rzym, Partner and Portfolio Manage at Man AHL, and Tarek Abou Zeid, Partner, Head of Client Portfolio Management at Man AHL, the authors question whether accuracy within hurricane season forecasts matters.
“The Atlantic hurricane season runs from 1 June to 30 November. Prior to the season start, a number of forecasters will predict the number of named storms (NS); hurricanes (H); major hurricanes (MH); and accumulated cyclone energy (ACE), a measure of the aggregate season activity,” Man Group said.
Research conducted by the firm shows that forecasters tend to underestimate outlier years.
In recent years, the two most active seasons, 2005 and 2020 and least active two seasons, 2009 and 2014, were under/overshot by all forecasters.
In addition, Man Group also outlined that pre-season forecasts are meant to give a sense of the upcoming season’s activity, and not the actual number of storms that are projected to make landfall.
“The issue with the latter is that landfall activity is guided by local weather patterns as the hurricane approaches, and these are only known a few days in advance.
“Even if we knew the exact number of hurricanes that would make landfall, that would not be sufficient to estimate the economic impact. Hurricane Milton from 2024 illustrated the point: by making landfall just south of Tampa Bay: a) a surge of the bay itself was avoided; b) the densely populated Tampa region north of the bay missed a direct hit. Making landfall a few tens of miles south made a large difference to the economic (and insured) impact,” Man Group explained.
Importantly, the firm also states that forecasting the number of storms that will occur within a season, their peak intensity, and their landfall location is still not sufficient to predict insured losses.
Man Group also highlighted that forecasting hurricane intensities at a location is further complicated by some storms experiencing rapid intensification (an effect which is very localised in nature), with explosive intensification seeming to be becoming more common.
Indeed, several of these issues came into play in 1992, a season that was relatively quiet, with six named storms, four hurricanes, and one major hurricane. Notably, hurricane Andrew occurred, making landfall in south Florida as a category five hurricane, resulting in unprecedented economic losses.
“So if what one cares about is an economic loss forecast for the season, then a season activity forecast inaccuracy is not terribly important, because so many other factors drive an impactful season,” Man Group added.
As previously mentioned, Man Group emphasised that catastrophe bond portfolio managers ought to prioritise robust portfolio construction instead of pursuing opportunities based on hurricane season predictions.
“Our view is that, rather than seeking opportunities based on forecasts, we should embrace unpredictability, and focus on robust portfolio construction. Specifically, we recognise that (through supply and demand) certain perils, triggers, and seniorities are more attractive than others, but this should be balanced by a desire for diversification. Doing so will naturally lead to a lower US wind and US quake exposure (relative to a market-cap allocation), balanced by being overweight some of the smaller perils,” the firm concluded.
It’s worth also reading about a prior study by Euler ILS Partners and Tropical Storm Risk (TSR), which suggests that making adjustments to the exposure of insurance-linked securities (ILS) portfolios based on inputs gleaned from the early July hurricane season forecast can drive opportunities to generate excess returns in reinsurance.
