A catastrophe bond (CAT) is a high-yield financing instrument designed to help insurance companies raise money in the case of a natural disaster. A CAT bond allows the issuer to obtain funds only if certain events, such as an earthquake or tornado, occur. The need to pay interest and refund the principal is either suspended or totally canceled if an event covered by the bond triggers a payout to the insurance provider.
What is the procedure for obtaining a catastrophe bond?
How do I get my hands on disaster bonds? Catastrophe bonds can be purchased directly or through a pooled insurance-linked securities (ILS) fund. ILS pooled funds are a straightforward method to get into the Insurance Linked Assets (ILS) market, and they can be made up of a range of different securities.
What is the best way to price a disaster bond?
Within a risk-pricing paradigm that deals with both systematic and non-systematic risk, a formula for the spread of Catastrophe Bonds is derived. The following is the formula: (EL)(1/) (EL)(1/) (EL)(1/) (EL)(1/) (EL) EL is the Expected Loss expressed as a percentage, and 1 is the Risk Aversion Level (RAL).
Who is authorised to issue catastrophe bonds?
Special purpose reinsurance companies based in the Cayman Islands, Bermuda, or Ireland issue the majority of disaster bonds. To safeguard buyers, most usually insurers (called “cedants”) or reinsurers, these organizations typically participate in one or more reinsurance treaties (called “retrocedents”). This contract may be structured as a derivative if one or more indices or event parameters (see below) “trigger” it rather than the cedant’s or retrocedent’s losses.
Some bonds provide protection against multiple losses.
Atlas Re (the first-second event bond) was issued in 1999.
Atlas II, the first third-event bond, was issued in 2001.
Bonds triggered by fourth through ninth losses have already been issued, including Avalon, Bay Haven, and Fremantle, all of which use tranching technology to track a basket of underlying events.
Gamut was the first actively managed pool of bonds and other contracts (“Catastrophe CDO”), with Nephila as the asset manager.
Which bond is the best?
Government, corporate, municipal, and mortgage bonds are among the several types of bonds available. Government bonds are generally the safest, although some corporate bonds are the riskiest of the basic bond categories. Credit risk and interest rate risk are the two most significant concerns for investors.
How do you go about purchasing kitty bonds?
Some mutual funds track an underlying index, such as the Swiss Re Cat Bond Performance Index, while investing in cat bonds. Individual investors interested in cat bonds should try investing in those mutual funds. Rather than buying a handful of separate cat bonds, the investor can hold a basket of them. Through diversity, this approach of mutual fund investment decreases risk.
What is the size of the catastrophe bond market?
This sum is slightly shy of $35.5 billion excluding mortgage agreements, while the outstanding market size for Rule 144a pure property catastrophe bonds is about $32.3 billion.
How are cat bonds bought and sold?
Through severe financial market dislocations, such as the dot-com bust and the credit crisis, CAT bonds have traded continually at non-distressed prices. Prior to the credit crisis, however, there was little visibility into the volume and pricing of CAT bond secondary market transactions.
How do cats and their owners form bonds?
According to a new study, while some cats appear more distant than dogs, they respond to the humans with whom they’ve formed bonds in a similar way.
Cats and their owners can create secure or insecure ties, according to research from Oregon State University. The researchers now feel the feature isn’t exclusive to dogs, as previous study has shown, because it also affects cats.
Researchers examine at how babies react when they’re reunited with their parent or caregiver after a brief separation during human attachment behavior studies. When they’re reunited, firmly attached newborns resume their carefree exploration of their environment. A secure bond is found in about 65 percent of newborns. Insecurely attached babies, on the other hand, would either avoid or cling to their parents.
The same tests have been carried out on primates. The researchers wanted to test what would happen if they added cats and kittens to the scenario after using it on dogs, newborns, and primates.
What does the ILS market entail?
Insurance-linked securities (ILS) are a result of financial innovation’s rapid growth and the convergence of the insurance and capital markets. Insurers looking to shift risk and access new capital markets funding have turned to the securitization concept. Investors are attracted to ILS from both the life and property/casualty (P/C) sectors.
While catastrophe bonds (cat bonds) continue to be the most popular type of ILS, there are also non-cat bond ILS, such as those based on death rates, longevity, and medical claim costs.
According to the Artemis Deal Directory, issuance of cat bonds and ILS totaled $3.3 billion in Q4 2019, up $1.1 billion from the 10-year average. In Q4, 15 transactions totaling $3.3 billion in new risk capital were completed, with 28 tranches of notes. Since 2015, just once has Q4 issuance exceeded $2 billion, so the fact that it has now surpassed $3 billion is significant. When combined with the previous three quarters of the year, Q4 2019 issuance increased the overall outstanding market size to a new high of $41 billion by the end of the year.
Despite a year-over-year decline of nearly $2.7 billion, issuance levels remained above $10 billion for the third year in a row. According to Artemis’ data, cat bond and ILS issuance in 2019 was the third largest ever recorded at $11.1 billion.
With $1.33 billion in issuance, or 40% of overall issuance, international multi-peril deals accounted for the highest share of Q4 issuance. Given the recent development of mortgage risk in the market, two mortgage ILS agreements were issued in Q4, accounting for roughly 27% of total issuance.
The average transaction size of Q4 2019 issuance was $219 million, which is somewhat lower than the 10-year average. The 15 transactions brought to market in Q4 2019 are more than the 10-year average of 10 and higher than the 14 recorded a year earlier. In terms of transaction size and number of agreements, the majority of cat bond and ILS issuance came to market in the first half of the year for the sixth year in a row. In the first six months of the year, 38 different transactions totaling approximately $6.4 billion were issued.
Cat bonds are a type of insurance-linked securities (ILS). P/C insurers and reinsurers utilize them to shift large risks on their books to capital market investors, such as hurricanes, windstorms, and earthquakes, lowering their overall reinsurance costs while freeing up money to underwrite new insurance business. Cat bonds are constructed so that payment of interest or principal to the reporting insurance company is contingent on the occurrence of a defined magnitude catastrophe event or an aggregate insurance loss exceeding a specified amount.
The risk inherent in cat bonds is one of the reasons these instruments are often short-term, with maturities ranging from three to five years. Out of the more than 300 transactions that have come to market in the nearly 20-year history of the cat bond market, 10 have resulted in a loss of principal to investors. Six of the ten historical losses were caused by insured loss events, while the other four were caused by credit events in the vehicle’s collateral due to the failure of the firm that guaranteed the bond’s collateral. The collateral structure utilized in credit-related losses, dubbed total return swaps, is no longer used in any outstanding cat bond, despite the fact that it was formerly the most often used. The most common collateral option right now is Treasury money market funds, followed by similar investment-grade assets.
Cat bonds remain an effective risk transfer instrument for sponsoring insurance firms as well as a good risk diversification tool for investors’ portfolios. Investors are looking for yield in alternative asset classes while interest rates remain at historic lows. The attractiveness of the ILS market, which has benefited from huge inflows from institutional investors, is highlighted by the spreads available in the high-yield markets. Returns have fallen in line with other fixed-income asset classes due to the lower interest rate environment. In this market characterized by persistently low interest rates, lower interest rates for ILS are nonetheless somewhat higher than similar corporates.
Insurers can and do invest in these assets on a limited basis, in addition to being issuers. These securities are purchased by insurance firms to diversify their portfolios. In most cases, insurers will not invest in a cat bond if they are already exposed to the hazard in their primary business.
The sidecar, which became popular after Hurricane Katrina, is another framework for transferring catastrophic risk to investors. Sidecars are primarily used by reinsurers in the aftermath of significant catastrophes to provide additional risk-bearing capacity during periods of high market stress. Sidecars are special-purpose vehicles in which reinsurers surrender premiums linked with a book of business to investors who put up enough money to ensure that claims are paid if they happen. Unlike cat bonds, which are structured as long-term products covering a wide range of risks and geographies, sidecars are short-term tactical vehicles used during a bear market.
As severe natural disasters become more common as a result of changing climate conditions, insurers and reinsurers may increase their issuance of cat bonds and sidecars to protect themselves from solvency-threatening losses.
The NAIC and state insurance regulators have devised a comprehensive national plan to assist manage catastrophe risk, which combines innovative risk management strategies with the solid basis of solvency and consumer protection inherent in state insurance regulation.
The ILS market also includes life insurance securitization. Life insurers use mortality and longevity risk securitizations in the same way as P/C insurance and reinsurance businesses use cat bonds and sidecars to shift risk to the capital markets.
Extreme risks of rising death rates as a result of natural disasters and pandemics could put a life insurer’s solvency at danger. An increase in mortality rates would have a negative impact on the quantity and timing of death benefits that an insurer is required to pay. The other side of mortality risk is longevity risk. An increase in longevity rates would result in higher annuity payments, which would increase financial outflows.
Life insurance companies have used securitization techniques to: 1) monetize the embedded value of a particular block of business in order to fund acquisition or demutualization costs; and 2) fund the extra reserves required by Model Regulation XXX and the Valuation of Life Insurance Policies Model Regulation (#830). A captive insurance firm is frequently at the heart of Model Regulation XXX life securitization schemes, serving as a repository for the proceeds of the securitization.
Corporate risk management approaches are based on a strong foundation of solvency and consumer protection provided by state insurance regulations.
The ILS market also includes life insurance securitization. For life insurers, mortality and longevity risk securitizations serve the same purpose as catastrophe bonds and sidecars do for property/casualty insurance and reinsurance companies: risk transfer to capital markets.
Extreme risks of rising death rates as a result of natural disasters and pandemics could put a life insurer’s solvency at danger. An increase in mortality rates would have a negative impact on the quantity and timing of death benefits that an insurer is required to pay. The other side of mortality risk is longevity risk. An increase in longevity rates would result in higher annuity payments, which would increase financial outflows.
Apart from transferring mortality risk, life insurance companies have used securitization techniques to: a) monetize the embedded value of a specific block of business in order to fund acquisition or demutualization costs, and b) fund the additional reserves required by Regulation XXX (Valuation of Life Insurance Policies Model Regulation #830). A captive insurance firm is frequently at the heart of Regulation XXX life securitization systems, serving as a repository for the proceeds of the securitization.