Investing in catastrophes

This story was originally covered by PRI’s The Takeaway. For more, listen to the audio above.

When natural disasters hit, investors get nervous. Some investors who are particularly affected are people who own catastrophe bonds, so-called “cat bonds” to bet against natural disasters.

Catastrophe bonds are “a growing market,” according to The New York Times financial correspondent Louise Story. They’re “a bit like those mortgage securities” that went bad during the financial crisis, Story told The Takeaway. The bonds are bundles of insurance risk surrounding natural disasters. Investors “are betting, hoping that the insurance policies don’t have to pay out.”

The bonds are attractive for some insurance companies that are hit hard by natural disasters. “When there are catastrophes,” Story explains, “the cat bonds have to cover the risk that the insurance companies took.”

A market for catastrophe bonds started to emerge after Hurricane Andrew, according to Story. Since then, Story says, “weather events have become a lot fiercer, more unpredictable.” That’s made insurance companies much more apt to issue catastrophe bonds to cover some of their risk.

The market is fueled by investors who are willing to take more risk than the insurance companies are willing to take. Problems could arise, though, if investors start getting nervous about the risk. Story says:

If it gets too big, will the investors out there at some point really panic when there are too many catastrophes? And does it put us back where we were a few years ago with mortgage bonds?

Most investors are unable to take part in the market, which is dominated by companies like Goldman Sachs. But as the market grows, Story recommends that people “watch this area very carefully.”

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“The Takeaway” is a national morning news program, delivering the news and analysis you need to catch up, start your day, and prepare for what’s ahead. The show is a co-production of WNYC and PRI, in editorial collaboration with the BBC, The New York Times Radio, and WGBH.