‘Double Down’ approach to buying cat bonds gains currency

Techniques for drumming up investment into cat bonds has evolved, with one new technique allowing investors to essentially “double down” as they would in Blackjack, said Philip Cook, CEO of Omega General Insurance Holdings.
Cook was the keynote speaker at the Insurance Institute’s Annual Industry Trends Breakfast on Jan. 13 in Toronto.
In Blackjack a player is dealt a minimum of two cards and can opt to a maxium of receiving three additional cards. The object is to get the total value of the cards as close as possible to 21 without going over (face cards count as 10 and aces can count as either 1 or 11).
In a ‘double down,’ a player has the option of doubling their bet after receiving their first two cards, usually if it looks to be a strong hand. But if the player ‘doubles down,’ he or she can only receive one additional card.
In cat bonds, it’s the opposite: an investor would “double down” if they have a bad hand.
If an investor is asked to commit $500 million to a cat bond, for example, he or she might be asked to invest 50% at the outset. The initial $250 million is used to write cat cover right away.
“Against the $250 million, you probably write about $150 million in premium,” Cook said. “If [the premium] is a 20% rate on line of $750 million worth of risk, and if you have no losses, you’ve just made a $150 million profit – or a 60% rate of return on your $250 million that was invested.
“But if there is a loss, and you blow the $250 million completely, the argument is that you would immediately put the other $250 million at risk. Because the premium you would be able to charge after a major hit to a cat bond is twice as much.
“Now you write the same amount of risk, $750 million, but at twice the premium, so you collect $300 million [in premium] and if there are no losses and you’ve created a 120% return on equity.”
Given the dire predictions about the number and severity of catastrophes being produced by models, Cook said he is not convinced the “double down” is necessarily a good bet. “But it’s a new way that investment in cat bonds is being sold now.”