Are cat bond investments cynical?
The most common misunderstanding about cat bonds that I encounter is that "it's cynical to invest in disaster". Quite often, this is a good starting point to explain the benefits of cat bonds: By transferring risk to the capital market, insurance companies can assume risks that would otherwise be difficult or impossible to accept. However, this misunderstanding sometimes makes it way into media, such as in an article at the web site of Sweden's leading business newspaper, where cat bond investments are portrayed as cynical.
The answer to the question if cat bonds are a cynical investment is easy: It is exactly the opposite. By investing in insurance risks, insurance is made available to more people in exposed areas. This is not only true in the rich Western world, but also, increasingly, in developing economies.
International institutions, such as the World Bank, OECD and IPCC would, of course, not advocate increased use of cat bonds because they are cynical, but because of the societal benefits they bring. Though the USA is today the primary market for cat bonds (and also in the US they are to a large extent used by state owned insurers of last resort), we see today a rapid development of cat bonds in other parts of the world.
In Mexico, a cat bond (MultiCat Mexico Class C) was, with a very high probability, triggered by the hurricane Patricia, the strongest hurricane ever observed along the American Pacific coast, though it is not clear yet whether it has triggered at 50% or 100%. Sixteen countries in the Caribbean are covered for hurricanes and earthquakes by the CCRIF programme. In both cases, the World Bank has been an enabler either, as in Mexico, providing a framework that facilitates the set-up of a cat bond, or, as in CCRIF, actually structuring the cat bond itself.
In 2016 we look forward to African cat bonds, as the African Union risk agency, the African Risk Capacity, will issue cat bonds to deal with climate related risks. At the recently held climate summit COP21, the financing of this program was a high priority issue for many African delegates.
The traditional response to a climate related catastrophe in Africa, such as draught or flooding, has been to gather a conference of donors. Typically, this will take some 18 months and the result will rarely live up to expectations. Even when pledges are made, the actual fulfillment of these pledges remain. A cat bond could result in a payment within four months from the occurence of the catastrophe, with a larger degree of automation. Thus, quick response is facilitated, prevventing the deepening of the catastrophe for a year before the world reacts.
The benefits of cat bonds has been a guiding principle for Entropics from the outset. Thus, we have adopted an ambitious Policy for Responsible Investments, to further strenghen this aspect. And we are, as we know of, the first specialized cat bond manager publishing key figures for responsible investments in our monthly report.
Are investments in increased security cynical? The answer is up to each person. But formyself, I sleep very well every night.