CAT BONDS AND THE JAPANESE EARTHQUAKE

CAT BONDS AND THE JAPANESE EARTHQUAKE. I posted here about catastrophe bonds and how the market for cat bonds took off after Hurricane Katrina. Hester Plumridge had an article in the Wall Street Journal (March 25) about the effect of the Japanese earthquake on the cat bond market. Cat bonds are bonds that serve as backup insurance (that is, reinsurance) in the event of a natural disaster. Bonds worth $1.7 billion—over 10% of the total cat bonds outstanding—are exposed to the Japanese earthquake. Since it is possible to lose all your investment in a cat bond in the event of a catastrophe, it would seem that this massive catastrophe would be bad for cat bonds. However, it is still unknown how much of the $1.7 billion will have to be paid out to cover losses on the earthquake. Hester Plumridge cites the opinion of Munich Re (“Re” as in “reinsurance”) that the earthquake may wind up boosting the cat bond market from about 1% of the catastrophe-insurance market to up to 4% to 5% of the market by 1015. Demand for catastrophe insurance should be increased by the catastrophe, which demonstrates the value of insurance. As for the supply of cat bonds, at a time when the returns on a lot of financial assets have been found to more correlated than they had been thought to be, cat bonds are are appealing to investors because their returns are not correlated with the returns on other financial assets.