The Financial Industry Regulatory Authority Inc. has released an investor warning on using catastrophe bonds and other event-linked securities. Catastrophe bonds are high-yield debt securities and are intended to raise money in the event of a disaster. Insurance and reinsurance companies issue them to institutional investors as a way of offloading risk and they take three years to mature.
Investors collect interest on the bond.
However, if a disaster does happen, and the issuer has a loss related to the catastrophe, the investors may lose their principal and unpaid interest.
Though the securities are available to institutional investors, such as mutual funds, Washington and New York-based Finra directed its warning to individual investors who may own shares in these funds.
Issuance of the bonds has skyrocketed in the last two years, with some $7 billion in publicly disclosed “cat” bond coming to market in 2007, according to Guy Carpenter & Co. LLC of New York.
In light of that popularity, Finra warned yesterday that cat bonds are normally rated BB or “non-investment grade” by credit rating agencies because the holders of the securities face “potentially huge losses.”
Trigger events, another important part of cat-bond deals, are detailed in the bonds’ offering documents —information that is only available to the purchasers, because these securities aren’t SEC-registered and are therefore exempt the commission’s disclosure requirements, Finra warned.
These triggers vary, and include parametric (wind speed for hurricane-linked bonds) and indemnity (when a sponsor/insurance carrier’s underwritten loss exceeds a predetermined amount).
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