Catastrophe bonds (“Cat Bonds”) are a form of insurance-linked security used to finance peak, non-recurrent insurance risks, such as hurricanes, tropical storms and earthquakes. Cat Bonds are the most common form of insurance-linked security and have grown in response to hard reinsurance markets and demand from specialist cat bond funds.
Cat Bonds are offered directly to capital markets, reducing cyclicality and expanding the risk bearing capacity of the reinsurance market. Cat Bonds are structured finance products that aim to isolate pure insurance risk from credit risk and other types of market risk and transform this risk into a capital markets form. Cat Bond volume has grown substantially in the last five years and Cat Bonds now occupy an important part of the property casualty retrocession market. Cat Bonds are attractive from an investor perspective because they are a non-correlated asset class and the yield is much higher than similarly rated corporate bonds. They do, however, require special expertise to analyze and tend to suffer a complete loss upon default.
This article broadly explains Cat Bonds: the most common forms; the reasons why (re)insurers and investors are attracted to Cat Bonds; shortcomings of Cat Bonds; how Cat Bonds are legally structured and regulated.
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