Cat Bonds - Overview

Catastrophe bonds (“Cat bonds”) and other risk-linked securities are innovative financial instruments having a significant role in the financing of mega-catastrophes. The importance of these vehicles stems from the fact that they provide access to capital markets directly thus expanding risk-bearing capacity beyond the limited capital held by insurers and reinsurers.

Cat bonds are not expected to replace reinsurance but rather complement the reinsurance market by providing additional capacity.

In a typical Cat bond transaction, a special-purpose vehicle (SPV) is formed. This SPV is usually owned by either a charitable trust or a special-purpose trust. The SPV issues a reinsurance contract to the sponsor (reinsurer) while simultaneously issuing limited recourse notes to investors. Proceeds from the notes are invested and deposited in a reinsurance trust in order to collateralize the reinsurance transaction.

Most event-linked bonds issued to date have been linked to catastrophes such as hurricanes and earthquakes with different types of triggers. Payments on catastrophe bonds may be triggered in a number of ways, such as:

  • An Indemnity trigger is based on the actual losses of the sponsor (reinsurer)
  • An Industry Index trigger is based on an industry-wide index of losses (e.g. Property Claims Service or “PCS” in the United States)
  • A Pure Parametric trigger is based on the actual reported physical event (i.e. magnitude of earthquake or wind speed of hurricane)
  • A Parametric Index trigger is a more refined version of a pure parametric trigger using more complicated formulas and more detailed measuring locations
  • For Modeled Loss trigger, losses are determined by inputting actual physical parameters into an escrow model which then calculates the loss.

While the great majority of Cat bonds issuance has been done out of the Cayman Islands, in 2009 Bermuda implemented a new regulatory regime for Special Purpose Insurer which includes Cat bonds.

The Horseshoe Group offers a broad range of services for the administration of SPVs in Cayman and Special Purpose Insurers in Bermuda.