Catastrophe bonds, also called cat bonds, are an example of insurance securitisation to create risk-linked securities which transfer a specific set of risks (generally catastrophe and natural disaster risks) from an issuer or sponsor to investors.
In this way investors take on the risks of a specified catastrophe or event occurring in return for attractive rates of investment.
The Catastrophe bond market is an expanding sub-sector of the ILS market, with quarterly issuance over the last few years often breaking records.
The typical catastrophe bond structure sees a special purpose vehicle or insurer (SPV or SPI) enter into a reinsurance agreement with a sponsor (or counterparty), receiving premiums from the sponsor in exchange for providing the coverage via the issued securities. The SPV issues the securities to investors and receives principal amounts in return. The principal is then deposited into a collateral account, where they are typically invested in highly rated money market funds.
The investors coupon, or interest payments, are made up of interest the SPV makes from the collateral and the premiums the sponsor pays.
If a qualifying event occurs which meets the trigger conditions to activate a payout, the SPV will liquidate collateral required to make the payment and reimburse the counterparty according to the terms of the catastrophe bond transaction.
If no trigger event occurs then the collateral is liquidated at the end of the cat bond term and investors are repaid.
A catastrophe bond can be structured to provide per-occurrence cover, so exposure to a single major loss event, or to provide aggregate cover, exposure to multiple events over the course of each annual risk-period.
Some catastrophe bond transactions work on a multiple loss approach and so are only triggered (or portions of the deals are) by second and subsequent events. This means that sponsors can issue a deal that will only be triggered by a second landfalling hurricane to hit a certain geographical location, for example.
Catastrophe bonds can be designed to provide insurance, reinsurance or retrocessional protection to the ultimate beneficiary of the coverage. In some cases additional parties are brought to a cat bond deal to enable coverage to cascade down to a corporate sponsor, for example.
The Artemis Deal Directory tracks the global catastrophe bond marketplace, including traditional 144A transactions and also privately placed deals, also known as cat bond lites.
For a more in-depth view of the catastrophe bond sector by quarter, see the quarterly Artemis cat bond & ILS market reports.