Catastrophe Bond
Insurance-Linked Securities
Definition
A catastrophe bond is an insurance-linked security where investors earn spread for taking specified natural catastrophe or insurance event risk, with principal at risk if triggers are met.
Why it matters
Cat bonds can diversify traditional credit exposure, but trigger design, modeled loss, peril concentration, seasonality, and collateral mechanics drive actual risk.
Common misconceptions
- •Cat bonds are not conventional corporate bonds; loss depends on insured event triggers.
- •A high spread can reflect tail risk that does not appear in recent realized losses.
Technical details
Trigger Types
Structures may use indemnity, industry loss, parametric, modeled loss, or hybrid triggers, each with different basis risk for sponsor and investor.
Collateral
Investor principal is typically held in collateral accounts invested in high-quality instruments, then released to the sponsor if the covered event meets contract terms.