Hedge Funds bet on Hurricanes

Hedge Funds bet on Hurricanes
In an article by Mike Anderson and Oliver Suess, Bloomberg poses a story with a twist on hedge funds and “catastrophe bonds.” As insurers sell more of the securities to protect themselves from increasingly unstable weather triggered by global warming.

Hurricane Katrina produced record claims of more than $90 billion last year. Hedge funds are embracing that risk, 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.

A 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. It has a special condition that states that if the issuer (insurance or reinsurance company) suffers a loss from a particular pre-defined catastrophe, then the issuer’s obligation to pay interest and/or repay the principal is either deferred or completely forgiven.

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.

``Global warming is leading to higher sea surface temperatures in the Atlantic, which is the most important factor for the rising intensity of hurricanes,’’ says Eberhard Faust, head of climate risk research at Munich Re’s Geo Risk Research department. The unit employs some 25 people, including scientists who analyze the likelihood of earthquakes, hurricanes and floods.

Invented after Hurricane Andrew devastated the Florida coast in 1992, triggering then-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, which paid more than 39 percentage points over the London interbank offered rate, or Libor, says Martin Bisping, the Zurich-based head of risk- sharing at Swiss Re. Those securities carry the highest reward because they cover multiple perils: North Atlantic hurricanes, European windstorms and earthquakes in California and Japan.

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