CAT Bonds

[callout]

Key Takeaways:‍

• CAT Bonds were introduced in the 1990s after Hurricane Andrew resulted in billions of damages.
• It pays out when a specific event occurs, such as an earthquake, hurricane, or tornado.
• Reduces risk and provides security for the insurance industry.

[/callout]

‍

Ever wonder how insurance companies don’t go bankrupt? That’s where CAT Bonds come in to play a crucial role in protecting insurers against natural disasters. CAT Bonds–short for Catastrophe–are a form of insurance-linked securities. 

‍

CAT Bonds were first introduced in the 1990s in the aftermath of Hurricane Andrew in 1992. Hurricane Andrew caused over $15.5 billion in insured property loss and resulted in the bankruptcy of 16 insurance companies. After realizing there wasn’t enough capital to provide the industry stability, CAT Bonds were introduced to provide a way to offset risks for insurance companies and governments. 

‍

So how does it work? 

When a specific event, like an earthquake or hurricane, occurs, the issuer will receive funding. That way they are protected if a natural disaster occurs. CAT Bonds pay high interests rates so investors can receive that interest rate over the life of the bond. It also allows insurance companies to lower their out-of-pocket costs when covering for natural disasters because of the capital raised through the bonds. This is ultimately another way to reduce the risk of going bankrupt. That being said, it is still risky for buyers of the securities since they have to predict that the event will occur before it happens. 

‍

But with global warming and the increasing risk of natural disasters, the CAT Bond has been growing. Similar to the futures market, traders can make gains when they correctly forecast whether an event will occur in the future.

‍