Word: cat bond Part of Speech: noun 1. Clipped compound of catastrophe bond. Example: Obtaining a financial rating is a critical step in issuing a CAT bond, because buyers use ratings to compare yields on CAT bonds with other corporate securities. Consequently, almost all bonds are issued with financial ratings. The ratings by bond issue volume from 2000 through 2006 are shown in Figure A9.7. The vast majority of CAT bonds issued in 2005 and 2006 have been below investment grade (ratings below BBB), that is, 93.0 percent of the 2005 issuance volume and 94.5 percent of the 2006 volume were rated BB or B. In 2007, there has been a resurgence in investment grade bonds (Swiss Re 2007a), although the majority of CAT bonds are below investment grade in 2007 as well. Although bond ratings lower than investment grade are generally bad news for insurers, reinsurers, and other corporate bond issuers, they are not necessarily adverse in the CAT bond market. Because CAT bonds are fully collateralized, CAT bond ratings tend to be determined by the probability that the bond principal will be hit by a triggering event. Thus, the bond ratings merely indicate the layer of catastrophic risk coverage provided by the bonds. In the past, the CAT bond market has been criticized for lack of investor interest. However, that assessment is now outdated—recent data suggest broad market interest in CAT bonds among institutional investors. Figure A9.8 shows the percentage of new issue volume by investor type in 1999 and 2007. In 1999, insurers and reinsurers were very prominent on both the supply and demand sides of the market and were among the leading investors in the bonds, accounting for 55 percent of the market. If insurers and reinsurers are on both sides of the market, the market cannot be said to have attracted very much new capital into the financing of catastrophic risk. However, by 2007, insurers and reinsurers accounted for only 7 percent of demand, suggesting that substantial external capital has been attracted to the market. Dedicated CAT funds accounted for 55 percent of the market in 2007, and money managers and hedge funds accounted for 36 percent. The declining spreads and increasingly broad market interest in the bonds suggest that the bonds are attractive to investors and are playing an increasingly important role relative to conventional reinsurance. Example: As the Trump administration stalls federal funding for projects intended to make states more resilient to climate change and private insurers decline to cover properties in high-risk zones, North Carolina just proved there’s another way to fund disaster preparedness: a $600 million catastrophe bond that rewards homeowners and their insurer for installing “super roofs.” Along North Carolina’s beaches, wind damage from hurricanes is such a threat that many private insurers have stopped offering coverage. Hundreds of thousands of homeowners have been forced to buy coverage from the North Carolina Insurance Underwriting Association (NCIUA), the state-created insurer of last resort for coastal properties. Like other insurers, NCIUA has to buy its own risk mitigation so it can pay customers if a major event causes more damage than it has saved from collecting and investing premiums. One option is reinsurance and another is a catastrophe bond, which pays out a specific amount if damage reaches a particularly severe level. Cat bonds have become popular with institutional investors like hedge funds and endowments in recent years because they trigger rarely and otherwise deliver high returns. For years, academics and brokers have discussed whether cat bonds could do more than just clean up after disasters—whether they could incentivize mitigation work that would lessen damages in the first place. Earlier this year, NCIUA decided to test it: They offered investors a cat bond with two features linked to reducing wind damage risks to homes in its portfolio. First, if no major losses occur each year, $2 million returns to NCIUA—earmarked exclusively to incentivize homeowners to install super roofs that are especially wind-resistant. Second, as more people add these roofs, the annual pricing on the bond resets to reflect the changing exposure. It’s modest financially but revolutionary conceptually, said Shalini Vajjhala, founder and executive director of PRE Collective, a San Diego-based nonprofit that works with communities and government agencies to clear barriers to building climate resilient infrastructure. “The North Carolina program is game-changing,” she said. “It’s a precedent-setting way of linking how you manage your financial risks with how you manage physical risks.” […] NCIUA says its financial analysis is that it will recoup $72 million over 10 years on the investment in roofs, some from avoided losses after storms but even more from having to purchase less reinsurance because their portfolio is less risky. With demand for roofs finally surging, Hardy wanted to make sure she had adequate capital for all the willing participants. She began looking beyond her own surplus to fund grants. Every year the association pays for a combination of reinsurance and cat bonds to cover portfolio risk. She had read about cat bonds with resilience features in academic literature and now wanted to make one a reality.