Catastrophe bond
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Catastrophe bonds (also known as cat bonds) are risk-linked
Catastrophe bonds emerged from a need by insurance companies to alleviate some of the risks they would face if a major catastrophe occurred, which would incur damages that they could not cover with the invested
For example, if an insurer has built up a portfolio of risks by insuring properties in Florida, then it might wish to pass some of this risk on so that it can remain solvent after a large
Michael Moriarty, Deputy Superintendent of the
History
The notion of securitizing catastrophe risks became prominent in the aftermath of
The market grew to $1–2 billion of issuance per year for the 1998–2001 period, and over $2 billion per year following
It is also possible to adapt these instruments to other contexts. Citigroup developed the Stability Note in 2003, which protects the issuer against catastrophic stock market crashes; it was later adapted to protect against hedge fund collapses.[8] Professor Lawrence A. Cunningham of George Washington University suggests adapting cat bonds to the risks that large auditing firms face in cases asserting massive securities law damages.[9] Other innovative uses of cat bond structures have been proposed as well.
Investors
Investors choose to invest in catastrophe bonds because their return is largely uncorrelated with the return on other investments in
Key categories of investors who participate in this market include
A number of specialized catastrophe-oriented funds play a significant role in the sector, including Twelve Capital,
Ratings
Cat bonds are often rated by an agency such as
Structure
Most catastrophe bonds are issued by special purpose reinsurance companies domiciled in the Cayman Islands, Bermuda, or Ireland. These companies typically participate in one or more reinsurance treaties to protect buyers, most commonly insurers (called "cedants") or reinsurers (called "retrocedents"). This contract may be structured as a derivative in cases in which it is "triggered" by one or more indices or event parameters (see below), rather than losses of the cedant or retrocedent.
Some bonds cover the risk that multiple losses will occur. The first-second event bond (Atlas Re) was issued in 1999. The first third event bond (Atlas II) was issued in 2001. Subsequently, bonds triggered by fourth through ninth losses have been issued, including Avalon, Bay Haven, and Fremantle, each of which apply tranching technology to baskets of underlying events. The first actively managed pool of bonds and other contracts ("Catastrophe CDO") called Gamut was issued in 2007, with Nephila as the asset manager.
Trigger types
The sponsor and investment bank that structures the cat bond must choose how the principal impairment is triggered. Cat bonds can be categorized into four basic trigger types.[12] The trigger types listed first are more correlated to the actual losses of the insurer sponsoring the cat bond. The trigger types listed farther down the list are not as highly correlated to the insurer's actual losses, so the cat bond has to be structured carefully and properly calibrated, but investors would not have to worry about the insurer's claims adjustment practices.
Indemnity: triggered by the issuer's actual losses, so the sponsor is indemnified, as if they had purchased traditional catastrophe reinsurance. If the layer specified in the cat bond is $100 million in excess of $500 million, and the total claims add up to more than $500 million, then the bond is triggered.
Modeled loss: instead of dealing with the company's actual claims, an exposure portfolio is constructed for use with catastrophe modeling software, and then when there is a large event, the event parameters are run against the exposure database in the cat model. If the modeled losses are above a specified threshold, the bond is triggered.
Indexed to industry loss: instead of adding up the insurer's claims, the cat bond is triggered when the insurance industry loss from a certain peril reaches a specified threshold, say $30 billion. The cat bond will specify who determines the industry loss; typically it is a recognized agency like PCS. "Modified index" linked securities customize the index to a company's own book of business by weighting the index results for various territories and lines of business.
Parametric: instead of being based on any claims (the insurer's actual claims, the modeled claims, or the industry's claims), the trigger is indexed to the natural hazard caused by nature. So the parameter would be the windspeed (for a hurricane bond), the ground acceleration (for an earthquake bond), or whatever is appropriate for the peril. Data for this parameter is collected at multiple reporting stations and then entered into specified formulae. For example, if a typhoon generates windspeeds greater than X meters per second at 50 of the 150 weather observation stations of the Japanese Meteorological Agency, the cat bond is triggered.
Parametric Index: Many firms are uncomfortable with pure parametric bonds due to the lack of correlation with actual loss. For instance, a bond may pay out based on the wind speed at 50 of the 150 stations mentioned above, but the insurer loses very little money because a majority of their exposure is concentrated in other locations. Models can give an approximation of loss as a function of the speed at differing locations, which are then used to give a payout function for the bond. These function as hybrid Parametric / Modeled loss bonds, and have lowered basis risk as well as more transparency.[13]
Market participants
Examples of cat bond sponsors include insurers, reinsurers, corporations, and government agencies. Over time, frequent issuers have included
To date, all direct catastrophe bond investors have been
Investment banks and Inter Dealer Brokers that are active in the trading and issuance of catastrophe bonds include
Patents
There are a number of issued US
See also
- Insurance-Linked Securities (ILS)
- Catastrophe modeling
- Fixed income
- Reinsurance
- Risk management
- Reinsurance sidecar
- Alternative risk transfer
- Year loss table
References
- ^ "Insurance-Linked Securities". Financial Industry Regulatory Authority. July 9, 2021. Retrieved May 30, 2024.
- ^ Insurance-Linked Securities and Catastrophe Bonds (PDF) (Report). American Academy of Actuaries. 2022. p. 10. Retrieved May 30, 2024.
- ^ Braun, Alexander; Kousky, Carolyn (2021). Catastrophe Bonds (PDF). Wharton Risk Center Primer (Report). Wharton School, Risk Management and Decision Processes Center. p. 5. Retrieved May 30, 2024.
- ^ "Insurance-Linked Securities". National Association of Insurance Commissioners, Center for Insurance Policy and Research. October 25, 2023. Retrieved May 30, 2024.
- ^ "GAO-02-941 Catastrophe Insurance Risks: The Role of Risk-Linked Securities and Factors Affecting Their Use" (PDF). Archived from the original (PDF) on February 3, 2011. Retrieved January 19, 2011.
- ^ "Catastrophe Bonds: Spreading Risk". Commdocs.house.gov. October 8, 2002. Retrieved January 19, 2011.
- ^ Lewis, Michael (August 26, 2007). "In Nature's Casino". The New York Times.
- ^ Dhillon, Hardeep (1 May 2007). "Betting on Stability". Risk. Retrieved 3 December 2013.
- ^ Lawrence A. Cunningham, Securitizing Audit Failure Risk: An Alternative to Damages Caps, William & Mary Law Review (2007)
- ^ "Twelve Capital AG - Artemis ILS Fund Managers Directory".
- ^ "Predictions for 2015: Diego Wauters, CEO, Coriolis Capital - Artemis.bm". 2 January 2015.
- ^ Boyd, Jeff (2016-08-26). "Modeling Fundamentals: So You Want to Issue a Cat Bond". Archived from the original on 2017-09-18.
- ^ "A.M. Best's Methodology: Gauging the Basis Risk of Catastrophe Bonds". Archived from the original on 2016-03-11.
- ^ Luis Flores Ballesteros. "Using international financial markets for funding disaster recovery- The case of an Earthquake Catastrophic Bond in Mexico" Latinoamerica Puede Sep. 2008:54 Pesos October 6, 2008. <"Using international financial markets for funding disaster recovery- the case of an Earthquake Catastrophic Bond in Mexico | Latinoamérica…puede". Archived from the original on 2011-08-19. Retrieved 2011-03-08.>
- ^ "World Bank Issues its First Ever Catastrophe Bond Linked to Natural Hazard Risks in Sixteen Caribbean Countries". www.worldbank.org. 2014-06-30. Archived from the original on 2018-02-23. Retrieved 2024-06-08.
- ^ "Catastrophe Bond Investors to Gain from Mild Hurricane Season". Insurancejournal.com. November 21, 2006. Retrieved January 19, 2011.
- ^ Examples of US patents and pending applications related to catastrophe bonds. U.S. patent 6,321,212 Financial products having a demand-based, adjustable return, and trading exchange therefore US patent application 2005/216386 Flexible catastrophe bond
External links
- Artemis Catastrophe Bond Deal Directory – list of all major cat bond deals
- "In Nature's Casino" (by Michael Lewis), New York Times Magazine, 8/26/07
- Cat Bond Pricing Using Probability Transforms (by Shaun S. Wang)
- Financial Innovations in Insurance – Panel Discussion in New York, January 2008
- Polacek, Andy (2018). "Catastrophe Bonds: A Primer and Retrospective". Chicago Fed Letter. 2018 (405). ISSN 0895-0164. Retrieved November 8, 2023.