Time for catastrophe bonds?

Time for catastrophe bonds?

News:

1. The recent floods in Kerala have set off a debate about the need for timely aid required to kickstart the relief process.

Important facts:

2. The idea that catastrophe risk could be securitised and that it could be dispersed among a wide number of investors was first mooted after hurricane ‘Andrew’ caused massive damages in the United States.

3. Catastrophe bonds are issued by insurance companies which have exposure to property and calamity insurance.

4. Under these bonds, the investors are compensated by a rate of return which is higher than that of normal government or corporate bonds.

5. The cost of issuing and managing catastrophe bonds is cheaper than the cost of reinsuring these risks and does the same function of transferring risk.

6. The instrument is a bond where the investor loses a part or whole of the capital based on certain pre-agreed conditions being triggered. These could be:

• Indemnity on losses faced by the insurer;
•  Modeled losses; or,
• Losses indexed to the total loss faced by the industry.

7. The market for catastrophe bonds was initially pegged in the range of $1-2 billion dollars in the initial years of 1998-2001.

8. Today, the total size of the catastrophe bond market is more than $30 billion.

9. The outstanding bonds in the first quarter of 2018 amounted to $35 billion.

10. Advantages for investors:

• Helps investors diversity risk. This is perhaps the only class of bonds that is not tied to economic performance parameters which would be the case in equity.
• The investors are compensated by a rate of return which is higher than that of normal government or corporate bonds. This helps them get extra returns on investment which in turn helps them to meet liabilities.

11. Way ahead:

• It is high time that such instruments are introduced in India so that relief and reconstruction work in areas affected by natural disasters goes on unimpeded and are no stalled for only want of capital.