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Bank guarantee for this purpose would add a 0.7% annual fee to the cost. Therefore, assuming that a catastrophe bond would be used for reinsurance cover at the 0.6%-1 % probability level, the total cost to the pool would be LIBOR + 4.7, or at current rates, 10.3%, substantially higher than an equivalent reinsurance premium. However, as per the earlier discussion, the proceeds of a catastrophe bond are to be invested in a trust account in risk free securities. The current U.S. treasury bill rate is approximately 4.9%. Thus, this investment would offset the cat bond financing costs by that amount and provide an approximate net cost of 5.4% = LIBOR + 4.7 - 4.9. So far we have excluded underwriting fees assumed to be an additional one time expense of 2%.

If we use the cat bond form of reinsurance for a $100 million loss limit, the total annual coupon payment 'premium' or rate-on-line equivalent would amount to $5.4 million, and the first year underwriting fee $2 million. In the financing structure of the pool listed earlier, a reinsurance premium of $21 million as a maximum was estimated, even though the current market rate-on-line for the same, would be $3.5 million, i.e., below the cat bond net interest payment. Therefore, based on the projected financial income and expenditure of the pool, a cat bond would still be affordable as an alternative method of reinsurance.

As discussed earlier, though, investors might only be receptive to purchasing such instrunents if the loss trigger was clearly defined and transparent. The current loss adjustment process and determination of indemnity payments in any given country might not be perceived as infornation which is symmetrical in its availability to both the investor and the insured. Because of this, a parametric trigger to determine the claims eligibility is proposed as the only feasible option even though this can generate potential basis risks. Nevertheless, with significant modeling based on hazard intensities at given sites and related dollar losses, a determination of the basis risk could be made. This would require use of meteorological measurements of windspeed and/or earthquake in islands which have suffered from disasters.

For improved 'payment triggering' under a catastrophe bond arrangement, heavy duty wind measuring devices for example, could be purchased and set up in selected spots on each island participating in the pool. These could be connected via wireless transmission to a central database administered by the pool as well as to an independent body such as the Miami Hurricane Center. Once an above threshold wind measurement was recorded, this would serve as the basis for declaring a pre-specified 'loss payment' from the bond, i.e., the bond proceeds would be used to indemnify for affected damages, in which case the investors would lose part of their principal and future interest.

While it would theoretically be possible for the pool administrators in conjunction with the domestic insurers to report exact losses on the ground, and thus allow the cat bond's loss on its principal be pro-rated accordingly, the institutional infrastructure for developing such a reporting system would not only take substantial time to implement, but as mentioned above, might not be attractive as a reporting system to the bond investors. Therefore, loss payments from cat bond proceeds might be structured parametrically as follows: