Cat bonds are a great tool to diversify portfolio as the weather does not listen to the stock market. We have covered the stories about few Cat Bond funds on the rise, this time we are questioning the possibility for the collateral to be in bitcoins.
What is collateral reinsurance?
Collateral reinsurance (CollateralizedRe) is a reinsurance treaty where a reinsurer inserts funds in a specialized collateral bank account to secure the obligation to cover its maximum liability in the event of a claim(s) under that contract are activated.
The need for such securities is drawn from low frequency high severity events such as natural disasters, mortality disasters and similar risks.
By taking an interest in collateralized reinsurance exercises a much needed cash-flow is injected. Collateralized reinsurance permits insurance linked securities (ILS) reserves, speculative stock investments, benefits reserves and unrated, outsider promoted reinsurance vehicles to take an interest in significant reinsurance programs.
What is Cat bond?
Special type of these Insurance linked securities are the Catastrophe bonds. CAT bonds are specialized in only one type of insurance – natural catastrophes (although might include different coverages). These types of insurance are usually covered with non proportional reinsurance treaties.
To simplify let us discuss how San Francisco and Tokyo can use Catastrophe Bonds to cover the damages of a natural disaster like an earthquake or tsunami. Investors can either give directly to San Francisco billions of dollars at the beginning of the year, or deposit it in a bank account. As all reinsurance treaties work – If an earthquake happens, San Fran can utilize these funds to instantly pay for rescue services and repair damages. However if the events included in the treaty did not occur by the end of the year, then San Fran will return billions of dollars and the Cat bond’s earned premium.
The premium is usually more than the fixed interest rate to accommodate the investor for the additional risk.
Investors use Cat bonds as a means of diversification of their investment portfolio. Weather patterns are unrelated to market variations making them a good complement to a balanced portfolio.
What Cat bonds can gain with blockchain?
Every bitcoin can be fragmented into one million pieces, commonly known as satoshis. How does this apply to Catastrophe Bonds? Well Catastrophe Bonds are huge multi-million dollar instruments and by this granulation a small portion of this risk can be offered to the regular Joe.
Imagine buying SanFranQuakeCoins using bitcoins, however your purchase being recorded as if it was in dollars. If by the end of the year no earthquake has occurred, San Francisco will repurchase the original coins with 8% interest. The return on investment is in that ballpark as Swiss Re Cat Bond average yearly return is 8.7%.
The investment in Cat bonds gives the possibility for the bitcoin owners to diversify by carrying part of their investment risk in dollars.
Additionally these tokens can be traded like any other cryptocurrency and this allows them to enjoy the liquidity that classic Catastrophe Bonds lack.
Blockchain plus Catastrophe Bonds bring a heap of benefits to society. They allow cities to transfer catastrophe risk to investors all around the world. They give diversification benefits to your everyday investor’s portfolio. And most importantly, blockchain will make Catastrophe Bonds more popular, allowing every city to have access to immediate finance incase disaster strikes. This will allow cities to fund emergency plans and save thousands of lives.