Create A Market For Catastrophe Bonds

Context: Catastrophe bonds (cat bonds) offers an attractive option for financing the rebuilding and rehabilitation after a disaster.

About catastrophe bonds

• Sponsored by reinsurance companies: The proceeds are kept in an escrow account and reinvested in low-risk products and transferred to the insurance company that faces a large payout on account of a catastrophe.
• Hazards:
  • Stipulate that interest and principal might be forgiven wholly or in part in the event of the occurrence of the calamity.
  • Care needs to be taken to prevent the possible mis-selling of these instruments to retail investors.
• Why would anyone want to invest in such bonds?
  • Such bonds would not be correlated with the business cycle.
  • These offer attractive yields and so can well be lapped up by long-term investors with the requisite risk appetite; Cat bonds are designed to offer relatively high coupon rates, have limited maturity periods of 3-4 years.
  • Risk is diversified across society at large: Pension funds, hedge funds, insurance companies cannot just afford but positively gain from cat bonds. Cat bonds use a market mechanism for risk transfer, that is all.
• Significance:
  • They are a direct, transparent way of financing disaster relief.
  • Removes the difficulties the government has in collecting taxes.