(Bloomberg) — As Los Angeles residents digested the apocalyptic scene left by wildfires earlier this year, the stage was simultaneously being set for hedge funds to pursue market-beating returns fanned by climate change.
The investment model in question is built around so-called subrogation claims, which are used by insurers to try to recoup some of the money they’ve paid out to policyholders. Insurers resort to subrogation when they suspect that a third party — a utility, for example — is ultimately responsible for the losses. But rather than deal with the recovery risk themselves, insurers have been selling those claims on to alternative investment managers.
Cherokee Acquisition has recently brokered subrogation deals for “larger, more sophisticated distressed debt hedge funds,” says Bradley Max, a director at the New York-based investment bank. Transactions have been tied to claims related to the Eaton and Palisades fires, he said.
Other investment firms looking to make money on claims stemming from the LA fires include Oppenheimer & Co., which recently executed a trade of subrogation claims, Bloomberg has previously reported. Investors have been paying about 40 cents to 45 cents on the dollar, according to Max.
As climate change leads to increasingly devastating natural disasters and unmanageable property losses, the question of who’s ultimately on the hook is more contentious than ever.
Fiona Chaney, senior investment manager and legal counsel for Omni Bridgeway, a specialist in subrogation claims and other forms of litigation finance, says the firm is readying for market growth as “claims get larger and larger.” Targets of subrogation claims have “paid out and paid out and paid out from so many massive wildfires,” so the motivation for insurers and investors is clear, she said.
Last year, insured losses hit $140 billion as natural catastrophes destroyed everything from critical infrastructure to private homes across the globe, according to Munich Re. The German reinsurer describes the development as a series of record-breaking events whose “consequences are devastating.” In all, natural disasters were responsible for $320 billion of losses in 2024, including those not covered by insurance, Munich Re estimates.
There’s widespread consensus that insurers alone can’t meet the growing coverage needs associated with the costs of climate change. In Europe, regulators warn that the widening gap in natural-catastrophe insurance protection requires a whole array of new policy responses. That includes greater capital markets participation, according to a discussion paper published by the European Central Bank and the European Insurance and Occupational Pensions Authority.
The role played by capital markets in helping insurers cope with their growing costs has tended to center on products like insurance-linked securities, including catastrophe bonds. But as natural-catastrophe losses soar, other investment models tied to insurance have followed suit.
The market for investing in subrogation claims had a seminal moment more than half a decade ago, when faulty power lines and equipment failures at California utility PG&E were blamed for wildfires in the state. Back then, hedge fund Baupost Group LLC purchased claims against PG&E worth $6.8 billion, from which it’s thought to have generated an estimated $1 billion of profits, Bloomberg reported at the time.
A spokesperson for Baupost declined to comment.
Max says that since the PG&E case, investors have increasingly seen “an opportunity to provide liquidity to insurance companies.” Typically, they’re looking at returns in the “low teens,” he said.
With transactions limited to over-the-counter deals, there’s little data available on prices or volumes. But those who are close to the market agree that “double-digit” returns are the standard, according to Michel Léonard, chief economist at the Insurance Information Institute.
Hedge funds, private equity firms and other alternative investment managers “are looking at extreme weather events in the context of insurance and thinking, ‘how can we invest and extract returns’,” Léonard said. And the risk-reward scenario they face is creating “consistent appetite,” he said.
For insurers, it’s about managing liquidity.
Going down the path of litigation “can be long and costly,” says Cherokee’s Max. Insurers that sell their claims get “cash today,” rather than having to wait for a resolution whose outcome is uncertain. “That’s part of what motivates the market,” he said.
In addition to claims tied to California’s fires, Cherokee has also “done transactions” for subrogation claims relating to fires in Hawaii, as well as to losses caused by Storm Uri in Texas, Max said.
For insurance companies, it’s a question of “taking advantage of the opportunity to eliminate risk and monetize their subrogation claims,” Max said.
(An AI summary was removed after it interpreted ‘double digit’ as a larger quantity than ‘low teens’)
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