Risky Business: A Case for Cat-Bonds in Florida's Insurance Crisis

Date of Award

2009

Document Type

Thesis

Degree Name

Bachelors

Department

Social Sciences

First Advisor

Strobel, Frederick

Keywords

Cat-Bond, Insurance, Hurricane, Florida, Market, Investing, Bond Catastrophe, Risk Management

Area of Concentration

Economics

Abstract

Following Hurricane Andrew in the mid 1990's insurers invented a new kind of bond to provide coverage for improbable, costly, catastrophes. Known as "cat-bonds" investors bought these bonds before a catastrophe ever happened. In return they received a high coupon-rate. However, if a catastrophe "triggered" the bond, then the investor would lose the bond's principal, which instead would pay the insurer's losses. This thesis accomplishes three objectives with regards to these bonds. First, I demonstrate these bonds' potential effectiveness and efficiency in financing the Florida Hurricane Catastrophe Fund's current coverage shortfall. Second, I demonstrate the attractiveness of cat-bonds to investors through modeling their low correlation with other asset classes over the last five years. Third I show how this low-correlation property broke down in 2008. I use the events of the 2008 financial crisis to build an explanatory model of this singular behavior.

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