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Catastrophe bonds

Catastrophe bonds

Catastrophe bonds, also known as cat bonds, are bonds generally issued by insurance or reinsurance companies in order to transfer part of the risks associated with exceptional natural events, such as hurricanes, earthquakes or tidal waves, to other operators and thus reduce their own exposure to natural disasters. In the case of classic bonds, the coupons and the repayment of the principal are derived from a mathematical formula; in the case of cat bonds, which are classed as insurance-linked securities (ILS), this formula is based on the occurrence of a predefined natural event. If such an event happens, the bond’s subscriber loses all or part of the interest, and potentially the principal. Cat bonds have a relatively short maturity (an average of three years).

These instruments appeared in the 1990s and they offer attractive characteristics for investors, with the main one being a means of diversification. Fluctuations in these assets are independent of economic conditions and they have a very low correlation to other assets. Further, they have low volatility and their risk/return ratio is generally seen as attractive. While insurers represent the bulk of the market, cat bonds have attracted other types of issuers, such as supra-state organisations like the World Bank (which issues bonds on behalf of countries threatened by catastrophes) and private companies.

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