By Kirill Graminschi
The trouble with Catastrophe Bonds
The article presents the difficulties insurance companies face when they are issuing catastrophe bonds. Do they efficiently hedge against large-scale disasters? It is very difficult hedging against catastrophic losses. Japan’s March earthquake, tsunami and nuclear disaster threat could cost the insurance industry between $21 and $34 billion. The catastrophe bonds are not helping much the insurance companies, although they were designed to do so. Catastrophe bonds have limits on type and location of the disaster they will cover. A large number of catastrophe bonds covered the losses only in Tokyo, although the actual losses occurred far away from there. In 1990s these risk-linked securities where designed to spread the risk to financial investors after Hurricane Andrew hit Florida and the quake in Northridge, California. The market works in the following way: an insurance company issues bonds to financial investors. During the life of the security the insurer is paying to the investor a coupon interest rate. If the loss is not occurring, the insurer returns the amount paid when the bond matures. If the loss occurs, the insurer is not returning any money and is using the funds paid by the investor to cover the losses. Many investors are satisfied with the returns on catastrophe bonds which results in unsatisfactory results of financial hedging to insurance companies. Despite the fact that catastrophe bonds are not providing the protection that the insurance companies would like to see on their books, there are no signs that the insurers might drop that option. According to Credit Suisse’s head of Insurance Linked Strategies Niklaus Hilti the long-term future of the catastrophe bonds in unpredictable. He also added that from the outlook of insurance companies, traditional reinsurance is a better hedge. Investors bet on Catastrophe Bonds
The article portrays the growing trend and...