Can catastrophe bonds save India from the financial burden of natural disasters?
insurance product recently introduced in global markets — natural catastrophe bonds, or 'cat bonds' — is being discussed. This unique hybrid insurance-cum-securitised financial product transfers hazard risk from the victim nation to global financial markets.
Cat bonds can lower the risk curve for low-frequency, high-impact hazards. Given India's credit standing and scale of its hazard risk profile, it could be cost-effective to sponsor such an instrument, through an intermediary like World Bank or ADB. The intermediary holds the principal amount until maturity as surety for the payout to the sponsoring country and assures its return to bond investors on the maturity of the cat bond.
Since catastrophe risk is difficult to forecast, disaster scientists assume that such a high-risk investment would be unprofitable for investors. On the contrary, risk-seeking investors find the disaster risk curve most attractive for diversification, since climate events are not correlated with financial market movements.
Pension funds, asset managers, hedge funds, family offices and even insurers are increasingly being attracted to cat bonds. Premium for this insurance (coupon rate) is part-paid by the sponsoring country and partly by the bank from the earnings it generates on the corpus collected.
The difference from normal bonds is that the principal amount is at risk of depletion in case the insured disaster occurs, also a justification for the higher coupon rate paid by the sponsor. Since 2018, several such bespoke products
