Catastrophe bonds: a financial symptom of climate change?

You can’t trust banks; can you trust insurers? Dan Box looks at the rise and rise of ‘catastrophe bonds’ – the new financial product with a very big downside

…Catastrophe bonds are, depending on who you talk to, either a smart way to spread the insurance risk around to ensure the market doesnt buckle under another Katrina, or a way of making money by trading on others’ misfortune. Swiss Re, the world’s second-biggest reinsurer, describes them saying: ‘Cat bonds offer investors an attractive risk/return profile and serve to diversify portfolio risk’.

Essentially, rather than taking out reinsurance, an insurer offers to sell a specific catastrophe bond. The buyer (say, a trader at an investment bank) puts down his money on the understanding that he will get it all back over time, plus a high rate of interest. The only catch is that he will lose it all if some specified bad thing happens within a specified number of years (say, Bermuda being wiped out by a hurricane). If it does, the insurer keeps the lot.

Catastrophe bonds are in their infancy, but you can measure their development against specific human tragedies. Between 1998-2001, the market grew to $1-2 bn of catastrophe bonds being issued per year. After 9-11, the market broke the $2 bn barrier. It doubled again, to roughly $4 bn a year, in 2006, after Hurricane Katrina. And having found its feet the market continued to grow, with over $4 bn being issued in the second quarter of 2007 alone.

You may not like them, and I’m not sure I do, but catastrophe bonds are one sure signpost to our new, climate-changed, world.

The Ecologist