Sales of catastrophe bonds growing rapidly

By Dan Box We are entering hurricane season again. As I write, the first of this year’s crop are working out their fury over the Atlantic and Pacific oceans while, in New Orleans, anniversary ceremonies are being held to mark the harvest claimed by Hurricane Katrina four years ago. … Catastrophe bonds are, depending on who you talk to, either a smart way to spread the insurance risk around to ensure the market doesn’t buckle under another Katrina, or a way of making money by trading on others’ misfortune. Swiss Re, the world’s second-biggest reinsurer, describes them saying: ‘Cat bonds offer investors an attractive risk/return profile and serve to diversify portfolio risk’. Essentially, rather than taking out reinsurance, an insurer offers to sell a specific catastrophe bond. The buyer (say, a trader at an investment bank) puts down his money on the understanding that he will get it all back over time, plus a high rate of interest. The only catch is that he will lose it all if some specified bad thing happens within a specified number of years (say, Bermuda being wiped out by a hurricane). If it does, the insurer keeps the lot. Catastrophe bonds are in their infancy, but you can measure their development against specific human tragedies. Between 1998-2001, the market grew to $1-2 bn of catastrophe bonds being issued per year. After 9-11, the market broke the $2 bn barrier. It doubled again, to roughly $4 bn a year, in 2006, after Hurricane Katrina. And having found its feet the market continued to grow, with over $4 bn being issued in the second quarter of 2007 alone. …