Some triggers are closely correlated to the sponsor’s actual losses and therefore operate more like traditional reinsurance, whereas others are not correlated in this way and the payment made under the bond to the sponsor may bear little resemblance to the actual losses, thereby providing a windfall for the sponsor. An example of the latter would be a bond that pays out to the sponsor based on a set wind speed at a specified number of weather stations, but the actual loss exposure of the sponsor arises in locations away from the weather stations specified.
Whilst traditionally cat bonds have been issued to cover the risk
of a particular loss, they have also been structured to cover the risk that multiple losses will occur, with the first second-event bond having been issued as long ago as 1999 and the first third-event bond having been issued in 2001.
Cat bonds are frequently rated by the traditional rating agencies,
but whereas a typical corporate bond is rated based on the likelihood of issuer default, a cat bond is rated based on the likelihood of the catastrophe arising and the principal being impaired as a result.
Institutional investors Who invests in a cat bond? Not surprisingly, bearing in mind the
high risk/high reward associated with cat bonds, the investors are typically institutionally-based and tend to comprise hedge funds, insurers, reinsurers, banks and pension funds. There is no doubt that the global financial crisis had a marked impact on cat bonds,
as hedge funds, in particular, bailed out because of the need to go into cash. The investors who remained had concerns about the transparency of the underlying collateral arrangements, particularly in the light of the collapse of Lehman in 2008. Lehman had acted as counterparty on a number of cat bonds. However, the lessons learned from Lehman have led to an improvement and simplification of the collateral arrangements, typically, through the use of US Treasuries and ‘AAA’ rated securities. Consequently, investors have returned, attracted not only by the higher coupon compared to corporate bonds, but by the diversification and lack of correlation to traditional assets classes that cat bonds can provide.
Cayman: a vibrant market As we approach the end of 2010, the cat bond industry remains
vibrant and Cayman appears to be in a very strong position to retain its position as the leading offshore domicile in this market. Its ambitions in this regard are not least reflected in the Insurance Law (2010 Revision), which for the first time, establishes a separate licensed category for cat bond SPVs. And further cementing its reputation, Cayman was, for the second year running, named by UK banking and finance magazine, The Banker, the number one specialised financial centre, globally. Such plaudits are unlikely to do Cayman any harm.
Paul Scrivener is head of the insurance group at Solomon Harris. He can be contacted at:
pscrivener@solomonharris.com
CAYMAN CAPTIVE 61
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