Hedge funds are embracing the risk of CAT, or catostrophe bonds, as insurers sell more of the securities to protect themselves from increasingly unstable weather triggered by global warming.
After seeing yields of as much as 40 percentage points more than investment grade debt, investors forecast sales of catastrophe bonds may triple to $4 billion this year. Hurricane Katrina produced record claims of more than $90 billion last year.
A CAT, or catastrophe bond is high yield debt instrument that usually pays higher yields because investors may lose their entire stake in the event of a disastert it is usually insurance linked and meant to raise money in case of a catastrophe such as a hurricane or earthquake. Interest generally ranges between 4 percent and 16 percent.
Invented after Hurricane Andrew devastated the Florida coast in 1992, triggering record losses of $20 billion, catastrophe bonds remained a minor tool for spreading insurance risk for the next decade.
Hedge funds bought the highest risk bonds, those securities carry the highest reward because they cover multiple perils: North Atlantic hurricanes, European windstorms, terrorist related threats, and earthquakes in California and Japan.
Now these investors have placed a billion-dollar bet that another Hurricane Katrina won’t hit the U.S. coastline. A big storm can disrupt energy supplies, causing a major fluctuation in the price of gasoline that sends shock waves through the economy.
After the busy 2004 storm season, in which four hurricanes hit Florida, and last year, when hurricanes Katrina and Rita devastated the Gulf Coast, more cat bonds are being issued than ever. If a big-enough storm hits, the investors could lose everything.
While politicians and scientists argue over the extent to which global warming is changing the planet, the insurance industry has concluded the phenomenon is real.
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