Someone explain a CAT bond to me

Hey all,

I have an interview coming up with a company that consults organizations on issuing CAT bonds. Could someone explain to me, in simple terms, what a CAT bond is? From what I've read online, it's pretty much when an insurance company issues a bond w/ a high interest, and if a catastrophe happens they are forgiven for the debt, but if no catastrophe happens, they pay the bondholder a hefty interest. Is that about right? Any help appreciated.

Thanks

Comments (10)

 
Best Response
Nov 26, 2017 - 5:58pm

DJA -

A catastrophe bond, or CAT bond, is a debt instrument used by insurance and reinsurance companies to limit their exposure to specific adverse events - California earthquakes, Florida hurricanes, etc. For example, if we examine recent hurricanes - Irma and Maria - that impacted Florida and PR, we can see CAT bonds in action.
Before the hurricane, insurers sold CAT bonds to alternative capital markets - hedge funds and institutional investors - at specific rates dependent on the bonds attachment points. The bonds attachment points - the point where the investor starts to lose their investment - are usually activated by total insured losses or total industry losses. The lower the attachment point of the bond, the higher rate is provided to the investor to compensate for the risk. If the FL hurricane hit the attachment point, the investor who put money in the tranch of 25 - 35 BN(11% coupon) of losses would lose their investment before someone who invested in the tranch of 45 - 65 BN(7% coupon).
CAT bonds have unique advantages for investors and insurance companies. Investing in CAT bond provides a level of diversification to an investor that is ideal - investing in an event that is not correlated with stock market performance whatsoever. For insurance and reinsurance companies, bonds allow them to mitigate their risk for specified events. In addition to risk mitigation, and seen in the recent quarter, CAT bonds also serve as a way to reduce reinsurance cost. Florida insurance companies that have higher concentration of CAT bonds are likely to be less adversely impacted by the reinsurance hardening that may insue in the coming year. While other insurance companies are stuck ceding more of their premiums to reinsurance companies, the CAT bond issuers will be able to hold onto more of the premiums they collect. If you have any further questions on CAT bonds, you should check out http://www.artemis.bm/.

 
Nov 28, 2017 - 12:06am

A catastrophe bond (CAT) is a high-yield debt instrument that is usually insurance-linked and meant to raise money in case of a catastrophe such as a hurricane or earthquake. It has a special condition that states if the issuer, such as the insurance or reinsurance company, suffers a loss from a particular pre-defined catastrophe, then its obligation to pay interest and/or repay the principal is either deferred or completely forgiven.

 
Nov 28, 2017 - 12:08am

CAT bond trading (Originally Posted: 10/22/2016)

Just looking to get some opinions, will banks/firms ever decide to commit an entire desk to CAT Bonds, and what desk is it being traded on right now? Structured Credit?

 
Nov 28, 2017 - 12:09am

I believe a large part of CAT bond trading is done by firms in the insurance industry. Check out Swiss Re Capital Markets for example. From what I understand many people in the insurance linked securities space started their careers at insurance firms, you have to really understand how the models work etc., much more than in other asset classes.

There has also been a push from banks / hedge funds to create reinsurance arms in the past.

 
Nov 28, 2017 - 12:10am

Cat Bond Investing (Originally Posted: 07/10/2011)

What groups at the BBs and any IB houses for that matter, underwrite these securities? And what are the various desks that are involved in the process: from origination, pricing, placement etc. Also, are there any HF's that exclusively trade cat bonds or if not at least have a significant allocation in them?

 
Nov 28, 2017 - 12:11am

Most have insurance linked securities desks. GS is pretty active. There's been a move over the last two years or so for most of the primary issuance to come from the securities groups of the major reinsurance brokerages (GC, Aon, Swiss Re). Many HFs are in the market, some dedicated, and there's been growth as pricing has ramped up following the events of the last 12-18 months. Some funds are cat bond only, but there are many other products which funds trade (ILWs, Collateralized UNL, Sidecars, etc.). The primary issuance market for 144A cat bonds has been extremely slow relative to maturation (driven in part by an unexpectedly large update to one of the third party risk models), making cat bond only a tough strategy.

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