Catastrophe bond
In consultation with an investment bank, it would create a special purpose entity that would issue the cat bond.
But if a hurricane were to hit Florida and trigger the cat bond, then the principal initially contributed by the investors would be transferred to the sponsor to pay its claims to policyholders.
[6] In August 2007 Michael Lewis, the author of Liar's Poker and Moneyball, wrote an article about catastrophe bonds that appeared in The New York Times Magazine, titled "In Nature's Casino.
"[7] The notion of securitizing catastrophe risks became prominent in the aftermath of Hurricane Andrew, notably in work published by Richard Sandor, Kenneth Froot, and a group of professors at the Wharton School who were seeking vehicles to bring more risk-bearing capacity to the catastrophe reinsurance market.
Issuance doubled again to a run rate of approximately $4 billion on an annual basis in 2006 following Hurricane Katrina, and was accompanied by the development of reinsurance sidecars.
A typical corporate bond is rated based on its probability of default due to the issuer going into bankruptcy.
This agent will generate a risk analysis of the bond taking into account the underlying structure of the notes using a catastrophe model.
Most catastrophe bonds are issued by special purpose reinsurance companies domiciled in the Cayman Islands, Bermuda, or Ireland.
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.
Cat bonds are generally issued under rule 144A and are commonly listed on the Bermuda Stock Exchange (though they trade OTC).
The sponsor and investment bank that structures the cat bond must choose how the principal impairment is triggered.
[13] The cover types listed first are more correlated to the actual losses of the insurer sponsoring the cat bond.
Indemnity: triggered by the issuer's actual losses, so the sponsor is indemnified, as if they had purchased traditional catastrophe reinsurance.
The cat bond will specify who determines the industry loss; typically it is a recognized agency like PCS or PERILS.
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.
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.
These function as hybrid Parametric / Modeled loss bonds, and have lowered basis risk as well as more transparency.
Per Occurrence: the loss from a single event must breach a threshold (the attachment level) to trigger the bond payout.
[17] More comparable to the cat bonds of today, the Vita Re transaction of 2003 on behalf of Swiss Re is claimed to be the "pioneer of life ILS globally".
[22] 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.
[23] Cyberattack: Beazley successfully sponsored the first Cyber cat bond in January 2023, dubbed "Cairney".
[24] The first public rule 144A cat bond was the Long Walk Re transaction in November of 2023, providing AXIS Capital with $75 million of Indemnity Per Occurrence coverage.
Examples of cat bond sponsors include insurers, reinsurers, corporations, and government agencies.
Over time, frequent issuers have included USAA, Scor SE, Swiss Re, Munich Re, Liberty Mutual, Hannover Re, Allianz, and Tokio Marine Nichido.
[28] In June 2014, the World Bank issued its first catastrophe bond linked to natural hazard (tropical cyclone and earthquake) risks in sixteen Caribbean countries,[29] and in 2017 it launched the Pandemic Emergency Financing Facility to provide funding in case of pandemic disease.
