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26 Sep 2006

Hedge Funds Cash out on Good weather

So far this year hurricanes are few and far between, but the intensity of last years storms caused hedge funds to bet billions of dollars on reinsurance.

The hedge funds that put these billion dollar bets on another Hurricane Katrina not hitting the U.S. coastline now have high expectations due to the forecasters prediction of a a mild hurricane season. There could be massive returns on their investment in CAT bonds.

A big storm can disrupt energy supplies, causing a major fluctuation in the price of gasoline that sends shock waves through the economy. If a big enough storm hits, the investors could lose everything.

Hedge funds “will have made a bomb”, according to one reinsurance broker. But it is difficult to calculate precisely the returns that hedge funds will make from reinsurance, given that most catastrophe bonds will have been bought and sold in private transactions.

Hedge funds piled into the reinsurance market after last year’s record hurricane season, which inflicted huge losses on the global insurance and reinsurance industries. Sales of catastrophe bonds may triple to $4 billion this year. Hurricane Katrina produced record claims of more than $90 billion last year. Cat bonds emerged after Hurricane Andrew devastated the Florida coast in 1992, triggering record losses of $20 billion.

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.