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Catastrophe Bonds A Market Answer To Hail Or High Water

Cat bonds can be issued for all manner of natural disasters, to protect against severe wind risks in the United States (pictured) or a Japanese earthquake. Some cat bond advocates say they have arrived on the market just in time. Peter Levene, chairman of the London-based Lloyd's insurance market, warned an audience of insurance executives in Washington last month that global insurers are facing the risk of a 100-billion-dollar "mega catastrophe twice the size of Katrina." And Warren Buffett, the savvy US billionaire whose interests include insurance assets, has said the losses from Katrina alone had cost his insurance groups some 2.5 billion dollars.
by Isabelle Tourne
New York (AFP) Feb 8, 2007
Facing the prospect of more volatile world weather patterns, especially devastating hurricanes, the financial markets have developed a new instrument to spread the risk: catastrophe bonds. Demand for catastrophe bonds, which are marketed to offset the financial risks of insuring against a mass storm or earthquake, has grown "explosively" in recent years, according to Rodrigo Araya, a vice president at the Moody's rating agency.

Such bonds, which are usually sponsored by insurers, offer yields above average interest rates to investors if a natural disaster does not occur over a given period.

But if a storm hits and an insurer must pay out claims, the bond investor loses everything, including the interest and principal.

Catastrophe bond issues grew to almost two billion dollars in value in 2005, prior to Hurricane Katrina ravaging the US Gulf coast, but today the market for such instruments is worth almost five billion dollars.

The so-called "cat bond" market debuted during the 1990s, and grew after Hurricane Andrew triggered the collapse of over 60 insurance firms, spurring insurers to radically rethink their risk management.

Transferring the financial risk of insurance to the financial markets seemed like an ideal solution.

Such bonds have found favor with hedge funds and offered money managers new avenues in which to diversify their complex investment portfolios.

Cat bonds also offer insurers and reinsurers a way to spread their risks against a sudden liquidity crunch in the wake of vast storm, some of which rack up billions of dollars in property damage.

And the market has not been diminished despite Katrina's late 2005 obliteration of New Orleans and the states of Louisiana and Mississippi, and the resulting 50 billion-dollar damage bill.

"Last year, (there were) almost no catastrophe hurricanes, investors did not suffer any significant losses, so they paid well, so there is more demand," Araya said.

The cat bond market has attracted the likes of Wilbur Ross, an American billionaire who made a fortune turning around troubled firms and who recently created a firm specializing in catastrophe risks.

"What we're betting on is that the perceived risk exceeds the actual risk," Ross said in a recent interview with the Wall Street Journal.

According to Mark Azzopardi, the head of BNP Paribas' insurance and pension operations, "for a given rating level, the investor is not taking more risk with a cat bond, just different risks which help to diversify their portfolios."

He said cat bonds can be issued for all manner of natural disasters, to protect against severe wind risks in the United States or a Japanese earthquake.

Some cat bond advocates say they have arrived on the market just in time.

Peter Levene, chairman of the London-based Lloyd's insurance market, warned an audience of insurance executives in Washington last month that global insurers are facing the risk of a 100-billion-dollar "mega catastrophe twice the size of Katrina."

And Warren Buffett, the savvy US billionaire whose interests include insurance assets, has said the losses from Katrina alone had cost his insurance groups some 2.5 billion dollars.

The demand for cat bonds is expected to pick up ahead of this year's Atlantic hurricane season which traditionally runs from June to November.

Source: Agence France-Presse

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