EDGE Magazine | Q3 2011


Paul Scrivener, head of the insurance group at Cayman Islands law firm, Solomon Harris, provides an insight into Cayman’s role in the global cat bond sector. PScrivener@solomonharris.com


C atastrophe bonds, or cat bonds


for short, first emerged in the aftermath of devastating Hurricane Andrew which hit South Florida in 1992. Reinsurers wanted to spread the risk burden and protect their balance sheets when faced with truly catastrophic claims. By late 2010 more than US$30 billion of securities had been issued. The Cayman Islands has become the leading jurisdiction for catastrophe bonds with the numbers of listed bonds now dwarfing Bermuda despite Bermuda's long-established reinsurance industry. In July 2010 there were 74 cat bonds listed on the Cayman Islands Stock Exchange with a value of over US$7.7 billion. In comparison, Bermuda had 10 listed bonds with an aggregate value of US$1.17 billion (US$1.814 billion by April 2011).


Cat bonds allow the insurance industry access to the capital markets and reduce insurance costs to end users. AM Best describes a cat bond as, "A structured debt instrument that transfers risks associated with low frequency/high severity events to investors". The key feature of a cat bond is that risk is transferred from reinsurers to investors. In this way, reinsurers avoid their balance sheets being substantially impaired where huge losses arise from natural disasters. The nature of the bond is a high yield debt instrument which is linked to an insurance risk, typically a catastrophic risk arising from a natural disaster such as a hurricane, earthquake or flood. Historically, cat bonds have been used principally to cover the risk of US hurricanes and earthquakes, Japanese typhoons and earthquakes and European storms.


The structuring of a cat bond is not 4


dissimilar to the structuring of asset- backed securities, a sector in which the Cayman Islands has always been particularly strong. The first Cayman cat bond was listed on the Cayman Islands Stock Exchange in 2007. An insurance company or a reinsurance company (the "Sponsor") establishes a Cayman Islands special purpose vehicle ("SPV") as a bankruptcy remote entity. The Sponsor pays premiums to the SPV with the SPV acting as a reinsurer of the Sponsor and the SPV raises its capital by the issuance of the cat bond to investors in the capital markets. The funds provided by the investors are deposited into a collateral account and invested in investment-grade securities such as US treasuries. The funds in the collateral account are available to satisfy any catastrophic losses that might arise. The cat bond carries a floating rate coupon which is serviced from the premiums paid by the Sponsor to the SPV and from the investment income earned on the funds in the collateral account.


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