Would You Let a 'Cat' Cross your Path This Halloween?
They were downright spooky last year, but Wall Street and the insurance industry seem to have gotten over their fright and are now ready to embrace "cat bonds" again.
A report from Guy Carpenter, the reinsurance broker for Marsh & McLennan, says that insurers may issue $1.2 billion to $2.2 billion in new catastrophe bonds during the fourth quarter, bringing the total to about $3 billion to $4 billion for the year.
Catastrophe bonds are an alternative to reinsurance, the insurance that property casualty insurers like Allstate need to protect themselves from major disasters like a tsunami or a Cat-e-gory Four Hurricane. But instead of going to a Bermuda reinsurer, insurers can buy a bond that allows them to collect if a natural disaster hits a certain level, such as an earthquake that reaches 7.6 on the Richter scale.
These bonds were the "cat's meow" after the 2005 hurricane season, when reinsurance liquidity was drying up because of the huge payouts from the three major storms that year: Katrina, Rita and Wilma. Together they caused more than $80 billion in damage, at least $25 million of it absorbed by reinsurers.
But the recession, and the collapse of bond traders like Lehman Brothers, scared off issuers and buyers alike when four of the firm's cat bonds were downgraded.
New cat bonds are expected to be issued by insurers such as Swiss Re, itself one of the biggest reinsurers and a pioneer in cat bonds. According to Guy Carpenter, prices for the bonds have dropped as lots of money is waiting to be put to work by banks, and investors are prepared to take lower returns.
Of course, there's always a ca(t)veat for investors. If a disaster does strike and meets the criteria for payout, an investor could lose whatever was paid into the bond. Investors are usually willing to take that risk, because hurricanes and earthquakes are unlikely to correlate with stock market crashes. In other words, it's unlikely that two black cats will cross your path at the same time.