Abstract
Catastrophic events like Hurricane Andrew and Hurricane Katrina can result in mega property insurance claims that can wipe out a fledgling insurance or reinsurance company and shake up the balance sheets of the stronger ones. The scarcity of reinsurance industry capacity and appetite for certain risks has resulted in insurance companies and others seeking capital markets solutions to obtain needed insurance or reinsurance capacity. One of the most popular and perhaps most efficient capital markets tools is the securitization of catastrophic risk through the issuance of risk-linked securities, also known as catastrophe or “cat” bonds. Unlike better known securitizations of cash flows, catastrophe bonds are effectively securitizations of insurance liabilities. This article examines the properties of catastrophe bonds and their usefulness in the reinsurance and capital markets arenas. Catastrophe bonds are a creative capital market alternative to the traditional reinsurance market, providing capital to permit insurers and reinsurers to increase their underwriting capacity and maintain and grow their client relationships. These transactions may also provide capital-intensive commercial businesses located in catastrophe-prone areas with access to coverage from the capital markets for risks that insurers are unwilling to assume or which are perceived to be overpriced. A significant feature of cat bond investments is portfolio diversification. Most fixed income investment portfolios are at risk primarily for credit deterioration or interest rate changes. Cat bonds bear little or no correlation with credit risk or interest-rate risk. There are three general transaction types associated with catastrophe bond issuances: indemnity, parametric/index, and modeled loss. <b>TOPICS:</b>Credit risk management, information providers/credit ratings
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