After the devastation in Japan two months ago, investors were keeping a watchful eye on the stock and bond market. It appears though, that the catastrophe bond (CAT bonds) division has been holding strong. Analysts and brokers have commented that no drastic price decreases or large spreads have occurred to cause them to be worried.
The recent earthquake and tsunami in Japan were what investors are calling the biggest adversity to happen since the financial woes of the Lehman Brothers filing for bankruptcy. The catastrophe bond sector is still strong and will still be considered as a choice for investors and brokers.
Cat bonds are risk linked securities that transfer a specific set of risks from a sponsor to an investor, and almost always deal with natural disasters. They first came about in the mid 1990’s after hurricane Andrew and the Northridge earthquake in California. Insurers needed to reduce part of the risk they faced in the occurrence of catastrophic events such as these.
An insurance company would issue bonds to an investment bank that turns and sells the bonds to investors. Over a specified amount of time (usually years) if no certain disaster occurs; the investor receives a big return on the investment risk he took.
On the other hand, if a certain catastrophe does occur, the money goes back to the insurer to use to pay claims; the investor gets nothing. That is why these types of investments are considered to be a naturally risky investment. Investors understand the risk involved with cat bonds, and they understand that they might lose money.
Certain areas insured for risk; like Japan for earthquake risk; only makes up a small portion of the overall large cat bond sector. With the event in Japan as large as it was; the total of exposed bonds from that is less than 15 percent.
