Recent disastrous events like the 9/11 incident have given the catastrophe bonds a new lease of life. They have become so popular that they are seriously being viewed as alternatives to reinsurance. These instruments are now reshaping the insurance industry.

The events of September 11 have affected businesses in more ways than one. Nowhere was the impact more intensely felt than in the insurance industry. The insurance claims were in billions of dollars and the reinsurers were counting their bills. The insurance rates surged and this turmoil seems to have given a fresh lease of life to the Catastrophe bonds.

Catastrophe bonds (or CAT Bonds, as they are called) are instruments issued usually by the reinsurers to hedge a part of the risk they bear. Part or the whole of the principal may be refundable in nature. This means the investor may not get back part or whole of the principal. If the principal is protected or secured, then the investor will get back the money after the tenure of the bond. Usually, a part of the principal is variable and a part is protected. The coupons are also different. The coupon on the protected part is lower compared to the variable part.

The returns for the investor depends on whether a particular catastrophe occurs or not. Thus for example, an investor may receive a 10 percent coupon and the entire principal if there is no hurricane or earthquake. However, if an earthquake does occur, then the investor may get (say) 5 percent coupon, and only half of the principal. In the extreme case, the investor may not get back anything at all.

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