Catastrophe Bonds: An Important New Financial Instrument

CAT bonds are issued by a reinsurer for indemnification against tail risks of a major disaster such as a hurricane, earthquake, or pandemic. The money with which investors purchase CAT bonds is deposited in safe securities such as US Treasuries. The investor then receives interest on these securities plus premiums paid regularly by the issuer of the bond. If a “triggering event” (the covered catastrophe) occurs before maturity the bond may “default” in that investors may not be returned part or all of their principal, which is used to cover insured claims. CAT bonds may be indemnity bonds, meaning that principal is used to pay claims if they exceed in aggregate some specified  minimum, or they may be “parametric” bonds if principal loss is triggered by a natural event, such as hurricane winds exceeding a specified minimum.