| It appears that holders of a CAT Bond (CATastrophe Bond) issued in August (!) by Swiss Re as part of a reinssurance agreement with Zurich Financial may just have lost the entirety of their invested capital.
Neither Kamp Re, the SPV set up to issue the USD190million Cat Bond, nor Swiss Re have yet confirmed that the CAT Bond would be triggered.
But given that investors are supposed to lose all their money if Zurich Financial Services incur losses of more than USD1billion in any single event and that their initial loss estimates related to Katrina currently amount to USD2billion, they can kiss their investment bye bye.
CAT bonds are a very interesting kind of instruments (people interested to know how to price CAT bonds can go to Baryshnikov). They were developped in the 90s after Hurrican Andrew devastated the insurance industry in 1992, with a view to spread the risk to non-insurance related investors, rather than only relying on reinsurance companies to mitigate the risk undertaken by insurance companies in the first place. Investors would benefit from high yields and to exposure to a new class of risk, hereby diversifying their risks further.
CAT bonds have been designed to only cover for "once in a century" kind of catastrophic events and none of them -except the Kamp Re one- have been triggered by Katrina (or Rita). Some investors may not have then fully understood what "once in a century" meant when they subscribed...or Swiss Re might not have fully explained what it was all about.
That leads me to share with you some insight on this industry. Reinsurers are not clear cut risk mitigators but mostly businessmen nowadays (at least those who understand the industry and who are not just wiped out after collecting 5 years of premiums and being hit by a catastrophic event).
In the early 70s, one of the -still- largest fire claim ever, by Ford over the destruction of their Koln (Germany) spare parts wharehouse (USD350million 35 years ago!) was to be paid by a German Insurer who had contracted a reinsurance policy.
To make a 30year long story short, it took 5 years for the claim related to the loss of business to be fully paid (of course, given that there was another warehouse in the UK and that Ford started shipping from there almost immediately,it generated an expert battle about the true excess cost of using this warehouse instead of the Koln based one), but then it took another 30 years for the insurer to REPAY the reinsurer the money they had been given to pay the claim in the first place, so that the reinsurer eventually did not lose anything because of the claim, leaving them with a small profit.
My point here is that, similarly to making any other investment, when investing in CAT Bonds make sure you fully understand what it is all about and you do not only assume it is easy money (i.e. high yield with little risk in capital). Reinsurance companie do have the means to fully assess the risk they are taking on and unless you benefit from the same tools and expertise, you should just pass on the "opportunity".
source: The Asian Wall Street Journal
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