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Rapid growth in the ILS sector has led to concerns that when a major catastrophe occurs, investors will face unexpected losses leading to panic and a rush of funds out the market, says Jay Patel, insurance analyst at business information service Timetric.
Despite being dismissed by Warren Buffett as a ‘fashionable asset class’ with a worsening outlook, we expect interest in catastrophe bonds to continue in 2016. Although issuances have been at roughly the same level for the past two years, at around $7 billion, the size of the market currently stands at $25 billion with steady growth expected in the forthcoming years.
Catastrophe bonds are a type of insurance-linked security (ILS) that enables re/insurers to reinsure catastrophe risk they have underwritten. Like a plain vanilla bond, they offer investors a specified coupon rate and at maturity, repayment of the principal. Where they differ is that, if a catastrophe occurs (as specified in the bond covenants) before maturity, investors will forfeit the principal and it will be used by insurers to pay outstanding claims that arise from the catastrophe.
The majority (approximately 86 percent) of perils covered by catastrophe bonds are located in the US, which is also home to 59 percent of catastrophe bond investors.
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