For a Layman, Catastrophe bond is a high yield debt instrument which is used by insurers to raise funds during a natural calamity. This concept was first practiced in the United States because of the regular occurrences of hurricanes and cyclones. It started in the year 1992 when the hurricane Andrew hit Florida and Louisiana. Following which in the year 2005, when Katrina came with damage of about $25 billion, it forced more than 11 insurance companies into bankruptcy. There was a need to develop new ways to raise capital to cover catastrophe insurance. The solution was to turn to the financial market which has way more investors as compared to the insurance markets. The insurance companies were facing huge difficulty in settling the claims of their policyholders. This was the time when the insurance companies started issuing Cat bonds. Here the funds are being invested in the money market with low risk. The bondholders get an annual interest which is higher than the average debt security interest rate in the market. There is a catch though! If any natural calamity occurs before the period of maturity of the bond and the damages cross a specific dollar limit set by the insurance company, the amount invested in these bonds is used to settle the claims. If not, the investors get a fairly good amount of interest every year following which they will receive the principal at maturity. Investors can use these securities to diversify the risk in their portfolios as they are not affected by the microeconomic factors. The interest rates stay the same even in bearish times. These bonds are traded in the OTC (Over the Counter) market and can be customized as per the investors’ and the issuers’ need. The reason that the Indian government should look into this is simple. Over the past years, the number of disasters on Indian soil has increased drastically.
Kedarnath landslides, followed by Kerala floods and currently the cyclone named Fani which has hit Orissa with a speed of 130 miles an hour. Over 1.1 million civilians were evacuated in less than 12 hours. More than 100 trains and flights were canceled. When the dust settles, there will be a need to cover the damage caused to these people. Whom will the insurance companies will look up to? Why do they have to rely on government relief funds when they have the solution right in front of them. Indian investors are a bit conservative compared to foreign investors. Hence the companies may customize the working of these bonds. Of course, they should pay a high yield to the investors but they may put a limit to the amount of these funds that will be used for providing coverage. The ratio can be 80:20 where the remaining 20 percent is returned back to the investors and only 80 percent of their principal is exhausted. Also, these bonds don’t have a high maturity period. Ideally, the time period is between 3 to 5 years.
Key takeaways: • CAT bond is a high yield debt instrument meant to raise capital for the insurance companies in the event of a natural disaster • A CAT bond allows the issuer to use the funds invested only if the specific event occurs and the damage coverage amount goes over the specific dollar limit • Investors receive a high rate of interest than most debt securities • If the specific event is triggered, the obligation to pay interest of return principal is either deferred or completely forgiven The Indian government can easily issue such bonds as they have a good credit rating in the eyes of the investors. Also, the benefit of this is simple: The response time to provide relief to the needful will be a lot quicker than it is now. Our government won’t have to look towards other countries for help in our tough times.
We have a chance to fulfill our social responsibilities through investing…
IBS TIMES OFFICIAL MEDIA PARTNER: NEWSWIRE
IBS TIMES OFFICAL PROMOTIONAL PARTNER: IBS MESSENGER
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