Financial Innovations for Catastrophe Risk: Cat Bonds and Beyond

Apr 01, 2008

Catastrophic losses from the Northridge earthquake, Hurricanes Andrew and Katrina, and widespread flooding in the early 1990s prompted many insurers to look for new market-based solutions to provide coverage in hazardous markets. As risks and costs continued to increase, however, insurance companies have had difficulty finding ways to cover these disaster-prone areas.

With a little bit of innovative thinking, and some help from capital market innovations, insurance companies could cover this risk and ensure that homeowners, businesses and communities are covered in case of a disaster. The key, the report states, is decreasing barriers in the emerging market of insurance-linked securities.

Catastrophe bonds - also known as cat bonds - and other insurance-linked securities are alternative sources of capital for insurers, reinsurers, governments and companies that can provide both capacity and price stability.

The report is based on a Milken Institute Financial Innovations Lab attended by representatives from the insurance, reinsurance, and bond ratings industries, along with practitioners in finance, law and government regulation. The Lab, which took place in October 2007 in New York City, and this subsequent report were supported by Allstate Insurance Company.

View update (May-June 2008).