It’s always some sort of scheme
Would The US Government Want To Issue CAT Bonds At Scale To Finance Losses From Climate Change?
Climate week just concluded in New York City. Instead of joining the chorus on how the US has withdrawn from the conversation, I thought I might write about something constructive. I have always worried that climate losses will eventually be socialized via greater deficits and eventually via greater taxation. What might an alternative look like? A private sector funded financing vehicle that can transfer risk from victims to a more risk loving investor, in exchange for appropriate returns. That is, something like CAT bonds.
For those who may not be familiar, CAT bonds are effectively insurance on tightly defined catastrophic climate events. The actual structure is a bit complicated. An SPV (special purpose vehicle) is formed by an insurance company. Investors pay let’s say $100 million to the SPV. This money will be used to pay out insured parties should the insurance company have to pay up if disaster strikes. Let’s say the disaster is a 7.0 earthquake in a specific tightly defined region. The cash that comes in from investors is usually invested in US treasuries, which pay say 5% per annum.
The insurance company hands off the premiums it receives from selling coverage of $100 million to the SPV. Let’s say that the premium is 6.5% on $100 million. The cumulative returns of 6.5% plus 5% on T-bills invested is passed on to investors every year till the disaster strikes. If disaster does not strike, the $100 million is returned to CAT bond investors at the end of the pre-arranged term, say at the end of three years. If the earthquake of 7.0 or higher does strike, the insurance company pays off the $100 million to insured parties.
So, they are very complicated, meaning hard to track the money. And, earthquakes are “climate” disasters?
The mechanism works because the returns to investors from a portfolio of CAT bonds exceed the loss payouts. To understand the nuances associated with the idea of US issuing CAT bonds at scale, I approached Andrew Poreda, and Sean McShea, friends and thoughtful commentators on climate finance. Their firm, Sage Advisory, has just launched a private fund consisting of traditional fixed income investments and CAT bonds. Before we hear from Andrew and Sean, a quick primer for folks who are not familiar with CAT bonds.
Yeah, I’ve heard enough. There’s always some scheme to take money from Some People and give it to Other People based on a manufactured cult scam. And, I’m pretty sure Trump would be a hard no on this.
