It is widely understood within the insurance industry that some forms of insurance are merely polite window dressing; if a $100 billion hurricane hits Florida, for example, homeowners are fucked. Now, investors are increasingly betting on no disasters happening. What could go wrong?
Say you have a house, and you buy insurance in case of natural disaster, and the insurance company goes to a bigger insurance company to buy reinsurance in case it gets hit with big claims for a natural disaster, and then they wonder to themselves, "Hmmm, where else can we spread around this god damn terrifying amount of risk?" Enter "catastrophe bonds," which savvy/ lucky-feeling investors buy, which are bonds that pay a nice fat percentage return—unless, of course, there is a big disaster, in which case you could lose it all. But hell, we haven't had any horrible disasters here in the USA in several years now, so.... party?
Last year these bonds paid off to investors at a rate of 11%, a great return in the bond market. Investing in these bonds is tantamount to a bet that there will not be a disaster this year which causes you to lose your investment. Most investors, of course (except The One True God) have no fucking way of knowing whether or not there's going to be a disaster this year. What they do know is, "Hey, we have a lot of cash floating around waiting to be invested, and these bonds have paid off pretty nice the last few years, and my astrologer told me there's not going to be a hurricane striking Miami this year, so hell, let's do it." The Wall Street Journal reports today:
With the U.S. hurricane season about a month away, insurers are issuing "catastrophe bonds" at the fastest clip since before the financial crisis...
Some say the increased demand for cat bonds reflects dangerous complacency on the part of investors who have driven the bonds' prices to unreasonable heights.
"The absence of a catastrophic event over a long period of time" has helped feed demand for the securities, said Al Selius,a portfolio manager at Pine River Capital Management LP, which has about $125 million in insurance-linked securities.
If a disaster hasn't happened in a while, that's a good sign a disaster won't happen this year, either. Uh, isn't that what that book Black Swan said? I've never been very good at math.
Anyhow, this is like, free money! Right?