The rich have a habit of high-stake gambles for making money. This has demonstrated itself over time, many times. Be it buying and storing cigars – high value hand crafted Havana’s, or wine from select vineyards with known pedigree or art or watches or pens. Of course, all of the highest quality with established provenance and certified. Stemming from these and in sync with the emergence of financialisation of everything is the new kid in the block – DISASTER BONDS. Or as they are more popularly known – CATASTROPHY Bonds or simply “catbonds”. Remember the movie The Big Short which attempts to explain the Lehman crisis and the unholy bundling of dubious loans into AAA category and how the entire edifice came down and brought the financial world down and created mayhem for everyone in the world. Well, it is not in the same league as the housing loans crisis in terms of scale or possible impact now but who knows…someday it might get so popular that banks and fund houses might issue product notes to sell to you and me.
So, what is a CATBOND???
A catastrophe bond (cat bond) is a high-yield, insurance-linked security designed to transfer specific, severe natural disaster risks—such as hurricanes, earthquakes, or wildfires—from insurers, reinsurers, or governments to investors. Simply put, there are many users who would like to insure against a natural disaster/s viz. shipping, logistics, airlines, farming, civil contracts et al. If the disaster does not happen, then the premium comes free. Essentially easy money. The same that takes place for our health and motor insurance. But if it does, the insurer would have to pay many times more than the premium value as the settlement of these consequences would run into the hundreds of millions of dollars. But as long as these don’t happen, the insurance companies make money. And since the “insured articles” extremely high value – think planes, commercial farms and equipment, mega oil tankers etc. the insured value is extremely high.
With El Nino and El Nina, the global climate cycle is going through turbulence, to say the least. Unpredictability is the predictable constant. And insurance companies are feeling a bit jittery. And the definite answer to this nervousness is f course the money bags. So, make a bundle of such few natural disaster insurance covers, make them into bonds and sell them to HNIs. The possible return is humongous. Of course, the flip side is – one could lose the shirt on their back. Big amounts, high risk and very high returns – what could be more addictive.
Is there a market for it? Some years back, the market for such bonds did not exist. Some two years back it was some 25 billion USD. Now it is some 70 billion USD. Essentially the growth of the market is 50 pc plus annually. And the way enquiries are taking place, there is every chance that this acquired giant proportions in the coming days.
Is it a diversification in the asset profile? You bet it is. There is nothing like this in your portfolio yet.
Is it adding to your return’s matrix? You bet it is. And more by way of a debt instrument than an equity exposure.
Does it provide liquidity?? Not really, unless a buy-sell is coordinated at the aggregators end with perfection. But then if one is investing in these kinds of instruments, it is likely that exit is not a key criterion. But when things go south we all know how HNI s react. So be aware of it.
Does it provide tax efficiency? Since the product has not come to the market yet we cant say how the treatment will go. But there is every chance this will be a debt product and the same rules will apply – returns added to total income and taxed as per slabs.
Should I buy it??? Will I?? The thrill is definitely alluring. And most probably I will. But I am a high risk taker. Which way will you move??
