EDGE Magazine | Q3 2011
Depending on a number of factors, but in particular whether the bond is parametric-based or indemnity-based (please see below), the yield can be between 3 per cent and 20 per cent over LIBOR. One particular advantage of the SPV being domiciled in a jurisdiction such as the Cayman Islands is that there is no withholding tax on the payment of the coupon. The typical term of a cat bond is three to five years. If the catastrophe does not occur, the investors receive their principal back at the end of the term and, of course, their interest during the term of the bond. However, if the catastrophe arises - a major hurricane hits the US East Coast or there is an earthquake in California - and the bond is triggered, the entirety of the investors' funds could be wiped out.
Whether or not the bond is triggered can be a complicated issue and there are various trigger types. Some triggers are closely correlated to the sponsor's actual losses (indemnity-based) 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 (parametric-based). The recent events in Japan demonstrate how parametric-based cat bonds work. Despite the enormous economic impact of the earthquake and the tsunami, it is believed that only a handful of bonds
with Japanese earthquake exposure will have been triggered. This is because most Japanese earthquake cat bonds were limited geographically to the Tokyo area and were therefore not triggered by the unfortunate events in the north east of the country.
Investors in cat bonds are typically institutionally-based and tend to comprise hedge funds, insurers, reinsurers, banks and pension funds. They are particularly attractive to
sophisticated investors because investment
performance is entirely uncorrelated to the performance of traditional asset classes. There is considerable investor appetite for cat bonds at the present time and it seems likely that this is set to continue with cat bonds now typically trading at a lower price than before the Japanese earthquake.
As the cat bond industry continues to develop Cayman appears to be in a very strong position to remain the leading offshore domicile in this market. Cayman is certainly setting out its stall to do so having recently revised it Insurance Law to establish for the first time a separate licensed category for cat bond SPVs. The future looks bright for this highly specialist sector of Cayman's insurance industry.
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