Johnson EG2014 Securitizedcatriskandclimatechange

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Geographies of Securitized Catastrophe Risk and the Implications of Climate


Change

Article in Economic Geography · February 2014


DOI: 10.1111/ecge.12048

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Geographies of Securitized Catastrophe

ECONOMIC GEOGRAPHY
Risk and the Implications of
Climate Change

abstract
Leigh Johnson This article analyzes the drivers and implications of
Department of Geography catastrophe bonds’ growing popularity as an alterna-
Winterthurerstrasse 190 tive asset class. As investor demand for bonds out-
University of Zürich paces their supply from reinsurers, the study asks
8057 Zürich how the place-based physical vulnerabilities of fixed
Switzerland capital have been rendered into assets deemed
[email protected]
increasingly desirable by growing blocks of financial
capital. Combining data from extended interviews
with industry datasets and market reports, the study
demonstrates how this securitization pathway allows
mobile capital on a search for yield to reframe spatial 155
Key words: liabilities as tradable assets, thus accessing new
risk transfer “returns on place.” By aggregating and analyzing
insurance data on approximately $37 billion in catastrophe
climate change

90(2):155–185. © 2014 Clark University.


bond transactions since 1997, the study reveals both
securitization the ongoing concentration of capital in so-called
catastrophe
“peak perils” such as U.S. hurricane and earthquake
adaptation
risks, and the fragmentation and recombination of
peak perils to create new risk/return profiles. These
purposive, scalable, and selective financial engage-
ments with catastrophic risks depend upon the avoid-
ance of the fixed costs and relational entanglements
borne by (re)insurers. This ambivalent relationship
with geographical liabilities is reaching its logical
apogee in recent proposals to expand the catastrophe
bond market to capitalize on growing climate change
risks. This movement to “underwrite to securitize”
intentionally emulates the “originate to securitize”
model pioneered in mortgage-backed securities. This
study argues that such developments could ulti-
mately yield a built environment that is both more
www.economicgeography.org

dependent on the state as an insurer of last resort and


less adapted to climate extremes.
ECONOMIC GEOGRAPHY

Acknowledgments Climate change could be a major driver for growth in the


insurance and reinsurance industry. . . . Over the long
term, it presents more of an opportunity than a threat.
Tremendous thanks are due
to the fund managers, —Barney Schauble,
modelers, and reinsurance managing director of the
executives and brokers who catastrophe investment fund Nephila Capital
shared their time and (quoted in Kent 2010)
candor with me. Christian
Berndt, Bob Meister, Scott Catastrophe bonds are quintessential examples of
Prudham, Richard Walker, the widely heralded “convergence” between reinsur-
and Michael Watts all ance and capital markets that began in the mid-1990s
provided invaluable support (cf. Culp 2002; World Economic Forum 2008). At that
and feedback on earlier time, simultaneous waves of deregulation and market
drafts; the article also consolidation, coupled with growing financial losses
benefitted from the insightful to natural catastrophes, paved the way for an array of
comments of several new instruments with which to hedge and speculate on
156 anonymous reviewers and the risks posed by weather and other natural hazards.
Andrés Rodríguez-Pose. The These new instruments included products to hedge
original spark for this article against “everyday” risks (typically weather deriva-
came from a collaboration tives based on temperature or precipitation) and con-
with Christopher Kobrak on tracts to cover massive losses following a catastrophic
a paper for the Insurance in natural disaster (typically insurance-linked securities,
History meeting held in June such as catastrophe bonds). Given the significant and
2009 at the Swiss Re Center growing geographic attention paid to weather deriva-
for Global Dialogue in tives (Pollard, Oldfield, Randalls, and Thornes 2008;
Zürich. Thanks also to Robin Pryke 2007; Randalls 2006; Thornes and Randalls
Pearson, Dwight Jaffee, 2007), this article turns to the relatively neglected
Frank Nutter, the insurance-linked securities (ILS) market. It follows
Reinsurance Association of Christophers’s (2009, 809–10) plea for more critical
America, and Swiss geographic research on not only the mechanics of
Reinsurance. Guy Carpenter financial “instruments themselves, but also their
Securities provided the implication in the processes, relations, and spaces of
historical data set of capital accumulation and its periodic crises”—crises
catastrophe bond issuances; that have necessarily been ecological as well as eco-
Claire Le Gall assisted with nomic (Moore 2000). In this light, careful scrutiny
processing the data. Trading should be applied to ILS market boosters’ coupled
Risk granted invaluable portrayal of climate change as a new frontier for
access to its publications. insurance-linked securitization on the one hand, and
This material is based on of catastrophe bonds as financial solutions to global
work supported by Grant climate policy failure on the other.
No. 0928711 from the To lay the groundwork for such an investigation,
National Science Foundation. this article’s first aim is to introduce and demystify
the catastrophe bond market while placing this “con-
vergence” in the broader contexts of contemporary
asset-backed securitization1 and finance capital’s
unending search for yield. Next, it considers the

1
In its generic sense, securitization simply refers to the technique
of pooling the contractual liabilities held by a financial
Vol. 90 No. 2 2014

uneven results of the market’s capacity to fashion geographic liabilities into strategic
resources, analyzing the development of the nearly $40 billion in natural catastrophe
bonds issued from 1997 through 2011 and characterizing the highly particular geo-
graphic footprint of this securitization pathway. Finally it argues that given the competi-
tive search for yield in insurance-linked investing, securitizing the geophysical effects of
climate change could generate new unexamined risks and maladaptive economic
responses.

Introducing Insurance-Linked Securitization to the


Geographies of Finance
In traditional catastrophe insurance relationships, the vulnerabilities of fixed capital
drive a revenue stream from asset owners to the guarantors of financial compensation
(typically insurers and reinsurers).2 The high annual variability and unpredictability of
insurers’ and reinsurers’ profits and losses and the cyclicity of insurance pricing have
typically discouraged traditional equity investors from investing in these firms’ shares.
Yet as the provision of catastrophe insurance has been securitized, these place-bound 157
vulnerabilities are rendered into an exploitable, diversifying asset class for financial

SECURITIZED CATASTROPHE RISK


capital. This development of practicable securitization pathways for geographic liabili-
ties has begun to give investors access to the $1.7 trillion in annual premium incomes
from the world of non-life insurance risks (Swiss Reinsurance 2010, 8). This
reconfiguration of hazard risk into asset class suggests some intriguing permutations of
Pike and Pollard’s (2010, 36) call for attention to “the ways in which the geographies of
assets and liabilities impinge upon their value and tradable potential.”
Catastrophe bonds (hereafter “cat bonds”) and insurance-linked securities more gen-
erally have been heralded as solving the problems of illiquidity and “lumpiness” that
characterize the catastrophe reinsurance industry—that is, the irregular and unpredict-
able demand for large quantities of liquid assets to pay claims (Jaffee and Russell 1997;
Kohn 2004). Cat bonds are designed to move especially concentrated geographic expo-
sures from an insurer’s or reinsurer’s portfolio outward into the broader financial
markets. The multiyear structure of bonds also allows these firms to secure coverage at
a set price for a number of years (typically three) rather than renegotiate prices on a
yearly basis. This is particularly significant due to the notorious cyclicity of reinsurance
pricing. (Re)insurers3 sponsor bonds that offer investors a relatively high rate of return in
exchange for financial protection from a particular kind of catastrophic loss exceeding a
prespecified trigger value. If a bond is “triggered” by a catastrophic event, investors lose

institution and selling them onward as a packaged financial product. Investors purchase a security based on
expectations of future income streams. In exchange, they contractually assume the liabilities associated
with that income stream, which are transferred off the original institution’s balance sheet.
2
Insurers purchase reinsurance to expand their own underwriting capacity and prevent massive payments of
claims from sending them into bankruptcy. Globally, roughly 10 percent of the non-life primary insurance
business (including property of all sorts, liability, and business interruption) is ceded to reinsurers (Group
of Thirty 2006, 18). In 2009, total global catastrophe reinsurance exposures were U.S. $205 billion (Swiss
Reinsurance 2009, 41; IAIS 2009).
3
Where applicable, this text uses the standard industry notation of “(re)insurance” to denote both the
reinsurance and insurance industries in cases in which their interests and structural positions in the
risk-transfer market are similar. The term also indicates that, in practice, it is not always possible to
distinguish clearly between the activities of reinsurers and insurers, since many large firms regularly
perform both roles (and may act as retrocessionaires selling reinsurance to other reinsurers). Examples
include Lloyd’s syndicates, Allianz, Berkshire Hathaway, and Swiss Reinsurance.
ECONOMIC GEOGRAPHY

part or all their principal. If not, they collect quarterly payments as well as a return of
their principal at the bond’s maturation date.
The most frequently securitized perils are the natural catastrophes with the greatest
potential to destroy insured property and generate associated business interruption and
workers’ compensation claims: hurricanes, earthquakes, and winter storms. Bond issu-
ances are always tied to specific perils in at least one geographic region (for example,
“California quake,” covering earthquakes in that state, or “European wind,” covering the
fierce extratropical cyclones that bear into Western Europe from the North Atlantic in the
winter months). Many are structured such that different tranches of the same bond cover
the sponsor for losses arising from separate perils in different geographic regions. A
growing number are explicitly multiperil across all tranches, meaning that the same
dollar of principal is exposed to two or more identified risks and locations. A bond’s
payout trigger may be based on the specific losses suffered by the sponsor, an estimate of
industry-wide losses, a modeled loss using event parameters fed into a catastrophe
model, or an indexed measure of event parameters such as average wind speed or ground
shaking (Hagedorn, Heigl, Mueller, and Seidler et al. 2009).
158 What is somewhat extraordinary in the risk-averse post-financial crisis climate is that
the cat bond market has experienced a growing and often unmet demand from the “buy
side.” A major portfolio manager complained in 2010 that overcapitalized reinsurers
were not passing enough risk onward to the capital markets: “Right now the market is
struggling with lack of issuance, not lack of investors” (Patel, quoted in Aon Benfield
2010, 33). In 2010 and again in 2011, Swiss private bank Clariden Leu temporarily
closed its popular ILS fund to new investors, blaming the insufficient issuance of new cat
bonds. The variety of investors accessing the market has also grown, with 2011 marking
the first year that institutional investors (including pension funds, sovereign wealth funds,
and foundations) outnumbered dedicated catastrophe funds (Aon Benfield 2011). This
overabundance of investors raises a question of broader significance for both the geog-
raphies of finance and the politics of environmental risk: how and why has investors’
interest in catastrophic risk remained so buoyant? This question is particularly puzzling
given that, first, the property insurance and reinsurance industries have typically been
bugbears for traditional equity investors, and, second, as reinsurers regularly warn,
climate change is generating greater uncertainty about the intensity, frequency, and
spatial distribution of extreme events.
The study presented in this article pursued three research questions to examine these
apparent contradictions: (1) As insurance exposures are rendered into “tradable poten-
tialities,” how and from where do these securities circulate, and what has been their
geographic development over time? (2) Why have these securities become an attractive
alternative asset class that is deemed increasingly investment-worthy by a growing
number of mainstream institutional investors, and what are the sociospatial ramifications
of this popularity? (3) Why do ILS market actors consistently frame potential changes in
extreme event patterns in terms of “opportunity,” and what are the implications of
securitization for risk management in areas that are increasingly vulnerable in a changing
climate?
The article proceeds stepwise to answer these questions. The remainder of the first
section reviews the literature on ILS within geography and cognate fields, suggests some
avenues of engagement with the geographies of finance, and introduces the study’s
methodological approach to researching capital markets. The second section reviews the
institutions, actors, and transactions that constitute the market, followed by an empirical
analysis of 15 years of cat bond issuance revealing patterns of geographic concentration
and recombination of so-called peak perils. The third section considers the specific
Vol. 90 No. 2 2014

characteristics of the ILS market—particularly, its promise of scalable and selective


access to risks with a low correlation to broader financial markets—that
characterize this novel securitization pathway. The fourth section examines recent pro-
posals to expand the catastrophe bond market through the emulation of the “originate-
to-securitize” model pioneered in mortgage-backed securities and raises concerns about
the industry’s self-conscious figuration of climate risks as new frontiers for securitization
and accumulation. The conclusion synthesizes the argument and suggests questions that
should motivate future research on catastrophe bonds.

ILS as Escape from Place? Risk, Insurance, and Financialization


The (re)insurance industry has rarely been a favorite of traditional equity investors.
Returns are notoriously volatile from year to year, making firms unattractive targets for
investment except immediately after major loss events when returns are unusually high.
For instance, the global reinsurance composite return on equity peaked in 2006 at nearly
22 percent, following the depletion of capital and rate increases after hurricanes Katrina,
Rita, and Wilma in 2005 (Guy Carpenter 2008, 4). The 2006 and 2007 combined ratios4
for the property-liability insurance industry were the “best back-to-back underwriting 159
performances in more than a half-century” (Hartwig 2008, n.p.). High volatility is only

SECURITIZED CATASTROPHE RISK


the beginning of the problem, though; direct insurers are also relatively encumbered by
the high fixed costs associated with sales, marketing, and claims adjustment. These
activities typically require direct insurers to maintain a spatially dispersed network of
offices, sales personnel, and adjusters (Kohn 2004). Because underwriting has tradition-
ally been built on long-term relationships in which trust is of central importance, both
insurers and reinsurers can be reticent to drop strategic clients and reconfigure their
underwriting portfolios to take advantage of short-term market dynamics (a topic to
which I return in the third section). All of these factors compelled one equity analyst I
observed to proclaim to a room full of insurance executives that their industry “is, was,
and always will be a lousy business to invest in, in the aggregate.”
Despite these frailties, the fact remains that the property-liability insurance industry
commands a staggering stream of real income in the form of premium payments,
collecting more than $1.7 trillion globally in 2009 (Swiss Reinsurance 2010, 8). This is
precisely the sort of alternative asset class that was targeted for securitization in the
1990s, pivoting on “the identification of a particular geography of revenues which were
previously considered trivial or off-limits and their incorporation into the financial
system by grossing up” (Leyshon and Thrift 2007, 101). Thus, the convergence of the
insurance industry and capital markets must be understood as congruent and coeval with
the larger trends toward asset-backed securitization and disintermediation that typified
global financial markets from the mid-1990s onward (Clark 2006; Lee, Clark, Pollard,
and Leyshon 2009). A number of broader economic factors made insurance-linked
securities feasible and attractive: the 1999 repeal of the Glass-Steagall Act, thus dispens-
ing with the regulatory separation of insurance, investment banking, and securities
underwriting in the United States; shrinking profit rates in traditional equity markets that
sent fund managers searching for new asset classes; and a series of disasters that depleted
reinsurance capital and raised the rates of return for investors in the sector.
Catastrophe bonds are by no means the only method by which insurance is being made
investment-worthy, although at this stage in the relatively young life of the ILS market,

4
A measure of underwriting profitability derived from the ratio of claims payments and expenses to total
premiums collected. Combined ratios for 2006 and 2007 were 92.4 and 95.6, respectively.
ECONOMIC GEOGRAPHY

they are by far the most visible products. Other securities, such as those linked to life or
automobile insurance policies, have been sold onward and a diversified ILS portfolio
often also includes non-catastrophic risks as well as catastrophe futures and options.5
Another popular subclass are privately traded swap contracts known as “industry loss
warranties,” whose payout depends on net industry losses exceeding a specified value.
Despite their rapid growth, relatively limited critical scholarly attention has been paid
to insurance-linked securities (Bougen 2003; Jagers, Paterson, and Stripple 2005;
Randalls 2009; Sturm and Oh 2010). Most of this work has focused on insurers’ and
reinsurers’ efforts to displace risk into capital markets, framing them within ongoing
discussions of Ulrich Beck’s (1992, 1999) famous postindustrial “risk society” in which
modernity’s technological developments become the source of catastrophic risks that
exceed the boundaries of calculability and control. As evidence of the “risk society,”
Beck has pointed repeatedly to the private insurance industry’s (alleged) refusal to write
coverage for risks from nuclear power plants, genetic engineering, and climate change,
among others. A significant debate has followed over the theoretical and empirical
validity of Beck’s uninsurability thesis, highlighting numerous techniques by which new
160 and seemingly “incalculable” risks are being rendered insurable and governable (Ericson
and Doyle 2004b; O’Malley 2003; Collier 2008). It is within this context that Bougen
(2003, 255) has asked whether catastrophe bonds may signal the emergence of a risk
network with “the necessary degrees of coherence between institutions and technologies
. . . for the practical functioning of catastrophe financing.” Sturm and Oh (2010) have
taken an explicitly geographic perspective, arguing that catastrophe bonds allow rein-
surers to solve the problem of ever-growing catastrophic losses through “scaled and
networked recovery schemes” that displace and spread risk. Similarly, Jagers et al.
(2005) have suggested that insurance-linked securities are strategic forms of privatized
environmental governance that are “becoming a dominant response” and “exit option”
for insurers who are seeking to manage the risks of climate change, allowing the industry
to displace the costs of climate impacts into the broader capital markets.6
These explanations are often accompanied by portrayals of capital markets as
bequeathing financial powers that free the insurance industry from its fatal ties to
absolute space. When the materialities of nature or space are considered, it is to highlight
them as problems, with all their messy specificity. The cat bond market is theorized as a
“way out” and “scaling up” for the insurance industry—a solution, albeit incomplete, to
the well-documented limitations of scale, capacity, and capital reserves within reinsur-
ance markets. Although these formulations usefully explain insurers’ and reinsurers’
motivations for seeking alternate sources of capital for underwriting, they do not offer a
convincing explanation of why investors would willingly buy into the market. This is
arguably because such accounts neglect the extent to which the (re)insurance industry’s

5
Compared to weather derivative markets, public trading in catastrophe derivative products has been staid.
Futures and options contracts that are indexed to measures of the intensity of individual storms are
currently traded on the Chicago Mercantile Exchange, but total volumes are quite small and parties
wishing to make large trades are often thwarted by the absence of market makers. Futures contracts based
on industry-wide losses to hurricanes (“IFEX” contracts that traded on the Chicago Climate Futures
Exchange from 2008 to 2012) are the newest addition to a long list of failed catastrophe derivatives and
options (Aon 2008; Csiszar 2007).
6
This conclusion is arguably overstated at present; at the market’s highest point in 2007, the $14 billion
of capital invested in natural catastrophe bonds represented less than 30 percent of global catastrophe
reinsurance limits; of this amount, only about 60 percent of bonds underwrote perils that were
weather-related.
Vol. 90 No. 2 2014

specific relationship to space and nature makes it a potentially promising investment


opportunity for other market participants.
Schematically, the ILS market is a contemporary financial permutation of a spatial fix
(Harvey 1982). It is a novel way for managers of circulating capital in search of higher
profit rates to take advantage of the physical vulnerability of place-bound fixed assets and
the resulting purchase of insurance coverage by asset owners. By “place-bound,” I refer
to the specific physical encumbrances of absolute space (Smith 2008 [1984]) manifest in
the built environment. In some cases the physical immobility of an asset creates its
vulnerability—for example, a refinery in the path of a hurricane. In other cases, the
connection of vital economic activities with physical places—for instance, airports or
hospitals—creates vulnerabilities to the disruption of systems (with resulting claims for
business interruption and workers’ compensation).
In other words, the ILS market demonstrates that the spatial encumbrances of financial
assets and liabilities do not simply impinge on their tradable potential as Pike and Pollard
(2010, 36) have suggested. These entanglements with the geophysical world also gener-
ate other kinds of tradable potentialities in the form of premium flows. As is discussed
later in the article, climate change is likely to multiply such tradable potentialities, 161
amplifying the possibilities for socioecological “fixes” for capital (Bakker 2009). It is
thus critical to grasp the relationship between place-bound vulnerabilities and the circu-

SECURITIZED CATASTROPHE RISK


lation of financial capital.
In this context, a host of recent studies on the geographies of financialization are
instructive. The research presented in this article draws on and contributes to several
themes within this scholarship. First, geographers have demonstrated an abiding atten-
tion to the material linkages between seemingly disembodied financial circuits and the
geographies of everyday components of the “real economy,” such as consumer credit,
residential mortgages, urban infrastructure, and taxation (Leyshon and Thrift 2007;
O’Neill 2009; Wainwright 2009; Pike and Pollard 2010). Such work resists decoupling
capital markets from space, instead insisting that “financial circuits and flows are
grounded in, produced by and thoroughly entangled with wider economic geographies
beyond the international financial system” (Hall 2013, 286). In this respect, the finan-
cial crisis laid bare the extent to which the material “geography of asset creation and
destruction” is orchestrated and/or magnified by financial channels (Lee et al. 2009,
740). Many have demonstrated this relationship with regard to the securitization of
income streams underlying residential mortgages, revealing the tendency of mortgage-
backed securitization to deepen indebtedness and urban inequality while magnifying
market volatility and systemic risk (Wyly, Atia, and Hammel 2004; Aalbers 2008;
Ashton 2009; Newman 2009; Ron Martin 2011). Nevertheless, these perspectives
have yet to be applied to a variety of alternative asset classes, such as ILS, that
construct new relationships between the circulation of finance and material economic
geographies.
Second, scholars with a wide variety of empirical foci have traced the technical and
political economic developments that made diverse securitization pathways feasible and
often highly profitable while increasing systemic risk. The “capitalization of almost
everything” (Leyshon and Thrift 2007) has been facilitated by the implementation of new
technical practices within financial institutions, such as the risk-based credit scoring of
borrowers, computerized geocoding, and computationally intensive models for pricing
synthetic securities (Wyly, Atia, and Hammel 2004; Randy Martin 2006; MacKenzie
2009). These techniques have gained acceptance amid shifting power relations between
market actors, including the rise of rating agencies as indispensible third-party trust
producers (Sinclair 2005; Engelen 2009); the regulatory “race-to-the-bottom” among
ECONOMIC GEOGRAPHY

Wall Street, the City of London, and offshore financial centers; and the amplification of
mimetic forms of rationality by the financial media (French, Leyshon, and Thrift 2009).
Together, this body of work has begun to demonstrate how the practices of hedging,
arbitrage, and the maximization of yields produced new risks and volatility in the course
of everyday operations that went on to ricochet through the global economy as the credit
crisis broke (Engelen and Faulconbridge 2009). Given that the popularity of cat bonds
has only grown following the financial crisis, it is appropriate to ask whether this market
harbors its own unexamined sources of risk and volatility.
Finally, economic geographers have begun to reconceptualize the spatial characteris-
tics and footprint of finance, calling for a finer-grained geographic account of the
processes that constitute financialization as such (Christophers 2011, Engelen 2012).
Contra the analytical units of the regulation school (Boyer 2000), they have suggested the
inadequacy of conceptualizing “financialization through the geographical prism of
national economic space” (French, Leyshon, and Wainwright 2012, 9; see also
Christophers 2011). The growth of the catastrophe bond market provides an opportunity
to trace how geographically exceptional parts of the built environment are selectively and
162 opportunistically accessed by financial capital, such that risks and profits surpass the
territorial logic of nation states.

Methodological Approaches to Capital Markets


The qualitative study of capital markets presents methodological and theoretical
challenges, particularly for privately placed (“over-the-counter”) markets like ILS.
Because catastrophe bonds are sold in unregistered sales according to terms set forth in
Rule 144A, which governs unregistered private resales of securities to qualified institu-
tional buyers under the U.S. Securities Act of 1933, there is no official clearinghouse of
information about investors or deals. The world of cat bond transactions remains, much
as that of collateralized debt obligations, “primarily one of private facts” (MacKenzie
2008, 25). This makes it tempting to rely on market promoters’ self-representation or
mediated reports about the market from the business and popular press; this has been the
strategy of choice for much of the work on ILS to date. But this method can also lead one
implicitly to replicate the discourse and assumptions with which these actors narrate the
story. This may be part of the reason why many scholars have continually framed ILS as
simply an escape from place for the reinsurance industry.
Understanding the implications of ILS for geography requires us to take investors
seriously as market actors who require specific kinds of information about risks embod-
ied in securities. As Bryan and Rafferty (2006, 7) have pointed out with regard to
derivatives, there is a tendency within the critical academic and popular literature to treat
these markets with “rhetorical, populist, and moralistic” disapproval for the speculation
they encourage (cf. LiPuma and Lee 2004). Insurance-linked securities—particularly the
evocative term catastrophe bonds—seem to inspire similar disapproval or, at least,
bewilderment from observers who think of investors blithely gambling on something as
fundamentally unpredictable as future weather or seismic activity. Even in Bougen’s
(2003) thoughtful essay, the catastrophe bond form is treated as a strange “mutant
offspring,” spectacularly fascinating because of the apparently unbounded risk appetites
of “financial speculators for whom no gamble is too great” (256–7, emphasis added).
Indeed, the entirety of Lewis’s (2007) cover story in the New York Times Magazine on
catastrophe bonds is premised on the metaphor of gambling “In Nature’s Casino.” The
caption on the magazine cover, published on the two-year anniversary of Hurricane
Katrina’s landfall, reads: “There will be another Katrina (or worse). It will cost insurers
and governments a fortune (or worse). Some hedge-fund managers are betting on it.” The
Vol. 90 No. 2 2014

language of gambling is not accidental, appealing as it does to deep-seated cultural norms


about legitimate versus illegitimate profits on risk (de Goede 2005). These moral sensi-
bilities are stoked even further by the cover image (“Hurricane #1” from Sasha Bezzubov’s
series “Things Fall Apart”) featuring an exterior wooden staircase that presumably once
led to a home but now ends abruptly, suspended in empty space. The implication is that
investors are making venal bets on destruction and human suffering.
Representations of the ILS market that treat investors as reckless gamblers are also
essentially endorsements of Beck’s (1992, 1999) uninsurability thesis, as if to say, “only
the truly reckless trader would willingly take on incalculable catastrophic risks that even
reinsurers have seen fit to shunt away.” This is the same logic that attributes crises and
financial failure to the behavior of greedy or incompetent “rogue traders,” rather than
following from the competitive imperatives and incentive structures that characterize the
financial sector (Tickell 1996; Clark 1997; Ho 2009). In fact, insurance-linked securities
are purchased by many different kinds of investors, including hedge funds, pension
funds, and reinsurers themselves, operating with various degrees of sophistication and
within diverse corporate bureaucracies for reporting and risk management (Clark and
Thrift 2005). There will inevitably be a few investors with uninformed or simply “aggres- 163
sive” positions on catastrophe risk. But boundless and implicitly irrational risk appetites
could not serve as a systemic explanation of the existence of the ILS market even before

SECURITIZED CATASTROPHE RISK


the financial meltdown of September 2008, much less afterward.
Taking all market participants seriously has methodological implications, requiring
research techniques that engage with and observe market actors in the course of their
routine work, while attending to extant quantitative and qualitative depictions of the ILS
market. Toward this end, the study presented here deployed methodological triangulation
(following Yeung 2003) between semistructured interviews, in situ observations, quan-
titative secondary data, and textual sources. Within economic geography, semistructured
interviews are well-established tools to generate evidence based on the “testimony of
participants in complex, ongoing processes whose material effects, but not necessarily
the rationales underlying them, are captured in our statistical data” (Schoenberger 1991,
181; Clark 1998). Interview methods were used to great effect by Ericson and Doyle
(2004b) in their studies of insurance underwriting and decision making at the “limits of
knowledge.” Although Ericson and Doyle did not rely exclusively on interview material,
fragments of their conversations with fund managers, underwriters, and executives oper-
ated as iterative touchstones for the organization of research. Such a close dialogue is
particularly appropriate for studies of newly emerging financial markets, allowing the
researcher to probe and explain novel market practices without replicating neoclassical
explanations of these markets as reflecting the most efficient method of allocating
capital, or presuming the rationales for market actors’ behavior through surveys with
fixed question and answer pairings (Clark 1998; McDowell 1992, 1998).
Research for this article was conducted as part of a larger multi-sited, mixed-methods
study of knowledge production and market reconfiguration in the reinsurance industry in
the context of climate change. The data that were drawn on for this article included 16
interviews with members of an international “hybrid network” of elites (Parry 1998)
within the ILS market, including bond sponsors, deal managers, broker-dealers, risk
modelers, reinsurers, and investors. Additional evidence was generated from attendance
and direct observation at four insurance-linked securities meetings in the United States
and the City of London ranging from half-day to nearly week-long events, and the
collection of market data from dedicated ILS industry newsletters and data compilers,
weblogs, and reports from reinsurance and ILS broker-dealer firms. Field research took
place over a two-year period from the spring of 2008 through the spring of 2010.
ECONOMIC GEOGRAPHY

The Structure and Geographies of Natural


Catastrophe Securitization
This section addresses the first research question, namely, how and from where do cat
bonds circulate, and what has been their geographic development over time? It marshalls
uses empirical examples and a data set representing 15 years of bond issuances to
develop a general account of securitization pathways and patterns. This analysis high-
lights the geographically concentrated and recombinant nature of securitized cata-
strophic risks and points out the necessity of occasional investment losses to sustain high
returns.
Securitization Pathways and the Circulation of Catastrophe Risks
Before considering the travels of an insurance portfolio in its securitized and
exchangeable form, let us review the traditional structure of catastrophic reinsurance
coverage and the role that a catastrophe bond can play in a firm’s risk transfer program.
Figure 1 presents a hypothetical example of a “CAT XL” (catastrophe excess-of-loss)
164 reinsurance and cat bond program that might be retained by a large primary insurer to
cover catastrophes affecting its U.S. book of business. Insurers typically purchase a
number of layers of coverage from different reinsurers, each with different “attachment”
and “exhaustion” points. In the case diagrammed in Figure 1, four separate reinsurers are
contracted to cover different “layers” of the primary insurer’s losses. The primary holds
the first $200 million in losses on its own balance sheet; this is meant to function roughly
like a deductible. The reinsurance contract with Reinsurer A attaches after $200 million
in losses and reaches its exhaustion point at $400 million, at which point the coverage
from Reinsurer B attaches, and so on. To prevent reckless underwriting and claims-

$350
Order in which tran-
ches are exhausted

Class A notes
$200 Class B notes

$100 Class C notes

1,200

1,000
Securitized Through Cat Bond issuance
Losses in Millions (U.S. $)

retains
Insurerretains

800
Reinsurer C Reinsurer D
DirectInsurer

600
Reinsurer B
Direct

400
Reinsurer A
200
Direct Insurer
0
0 25 50 75 100
Percentage of Losses Held Within Each Layer

Figure 1. Hypothetical reinsurance program and catastrophe bond structure for a large insurer’s
natural catastrophe reinsurance coverage.
Vol. 90 No. 2 2014

Insured Policy
Holders

Insurance Company
Catastrophe
“Cedant”
Modeling Firm
(fee
s) Rating Agency

Collateral Special
often deposited in Treasury Purpose Deal Manager
money market funds,
or with Total Return Swap
Vehicle
counterparty (as
is n sumin
ot t g b
rig o
ger nd
ed )
-Hedge funds Cat Bond
Initial funds exchanged
Regular payments
Contingent payments
-Dedicated cat funds
-Reinsurers
-Institutional investors
(pension funds, foundations,
} Investors
165

SECURITIZED CATASTROPHE RISK


sovereign wealth, etc)

Figure 2. A typical catastrophe bond transaction structure.

handling practices, reinsurers typically mandate that the primary insurer remain respon-
sible for some significant proportion of losses above the reinsurance attachment point.
Here the primary insurer remains liable for 10 percent of any losses between $200
million and $1.15 billion and all losses above that amount.
In this hypothetical case, the primary insurer has sponsored a $350 million cat bond in
three tranches that substitutes for a top layer of reinsurance coverage and is triggered only
after losses exceed $800 million. In the existing market, roughly half of all bond
issuances come from primaries. State Farm and U.S. military insurer USAA are currently
the most frequent sponsors, with Zurich Financial, Allianz, Chubb and AXA also acting
as repeat players. In the case of bond issuance by reinsurers, the tranches and trigger
structure remain similar. Global reinsurance giants Swiss Reinsurance and Munich
Reinsurance account for the largest share of these issues, with French firm SCOR also
sponsoring consistently.
If the bond is triggered, the capital to compensate the sponsor for losses comes first
from the most “junior” tranche, in this case the Class C notes. As losses mount, the more
senior notes are tapped. Some senior tranches guarantee to return part or all of investors’
principal; such “protected” tranches may be rated as investment grade by ratings agen-
cies. The unprotected tranches offer higher rates of return, but feature no such guarantees
on the principal.
A relatively standard institutional and legal structure has been developed to issue cat
bonds, schematized in Figure 2. The sponsoring (re)insurer—the “cedant” of the risk—
creates an independent and legally distinct special purpose vehicle (SPV) that is domi-
ciled offshore, most often in the Cayman Islands.7 The SPV acts as the functional
equivalent of a reinsurer to the sponsor, who pays it an initial premium that is deposited

7
The Caymans gained popularity as a domicile for the SPVs of collateralized debt obligations because there
is no withholding tax on coupon payments to investors from the bond’s collateral account.
ECONOMIC GEOGRAPHY

in a trust. In exchange, the SPV issues notes to investors, whose principal is also
deposited in the same trust. The trust safeguards the bond’s collateral, often investing the
collateral in a money market fund of U.S. Treasury bonds.
The cedant also pays significant fees to third parties, including (1) a deal manager to
oversee the marketing of the bond, (2) a catastrophe modeling firm to model expected
losses on the portfolio, and (3) a rating agency to produce an external evaluation of the
bond’s credit-worthiness. Analysis by a catastrophe model, which joins thousands of
stochastic event sets with engineering damage modules and highly granular data on the
underlying geographies of exposure in the built environment, is an absolute prerequisite
for the development of pricing guidelines based on expected losses (Johnson 2013). Cat
model output is also a major factor considered by bond rating agencies—which do not
themselves perform any catastrophe modeling—when assigning ratings to catastrophe
bonds (cf. Standard & Poor’s 2009).8
Given the scale of risks, the technicality of the offerings, and the expertise required,
most investors in ILS are quite specialized. From 2008 to 2011, 35 percent to 45 percent
of the total investments in cat bonds were made by roughly 25 dedicated “cat funds”
166 —privately managed funds that were launched in the years following September 11 and
Hurricane Katrina when there were large returns on capital. These are essentially single-
strategy hedge funds that invest only in insurance-linked securities. Quite a few of these
dedicated funds are either direct spin-offs from reinsurance or insurance companies or
were launched with seed money from insurers who retain some financial interest. The
segmentation of the remaining investor base varies dramatically depending on the con-
ditions within the larger capital market and the point in the reinsurance pricing cycle.
Aon Benfield (2011) reported the following breakdown for deals it managed in 2011:
institutional investors, 44 percent; dedicated catastrophe funds, 34 percent; mutual funds,
10 percent; reinsurers, 7 percent; and multistrategy hedge funds, 5 percent. Notably, 2011
marked the first year that the institutional investors, including public-sector pension
funds, sovereign wealth funds, and foundations, surpassed dedicated catastrophe funds as
the largest block of investors, up from 31 percent the previous year. There is also a
distinct geographic signature of the demographics of cat bond investors; again for 2011
Aon Benfield deals, 47 percent of investors came from the United States, 33 percent from
Switzerland, 7 percent from Bermuda, 5 percent from the United Kingdom, and 8 percent
from elsewhere.
In the 15-year history of the catastrophe bond market, the direct connection between the
financial capital invested in cat bonds and the at-risk landscapes they underwrite has rarely
been evidenced through bond defaults. Although (re)insurers handle millions of claims
annually, by the end of 2011 only a handful of cat bonds out of nearly 200 issued had been
triggered by insurance losses. One of the most notable defaults to date was Kamp Re,
sponsored by the primary insurer Zurich Financial Services to cover U.S. hurricane and
earthquake claims if the firm’s total losses exceeded $1 billion in a three-year period. The
deal closed on July 28, 2005, just one month before Hurricane Katrina began to wreak
havoc on the Gulf Coast. By October, Kamp Re notes were trading at pennies on the dollar
in the expectation of a total loss (Lane and Beckwith 2010). The administration of
outstanding claims finally concluded at the end of 2010, and Kamp Re returned roughly

8
Other components of this research explored the tremendous influence of catastrophe modeling and its
associated epistemic practices within the (re)insurance industry as a whole (Johnson 2011). I do not detail
these arguments here except to note the importance of models as calculative devices (Lepinay 2007;
Muniesa, Millo, and Callon 2007) that create an operable equivalence between perils of different onto-
logical orders and allow for the commodification of insurers’ contingent exposures.
Vol. 90 No. 2 2014

$0.25 on every dollar of principal to investors (Trading Risk 2011a). Hurricane Ike’s
colossal damage to offshore energy assets in 2008 also looked likely to trigger a loss on
junior notes covering Glacier Reinsurance for U.S. wind and quake, but investors disputed
the legitimacy of Glacier’s proof of loss in arbitration and eventually recouped the entirety
of the principal (Trading Risk 2013a). Of the six bonds with any exposure to the Japanese
megaquake and tsunami of 2011, only two triggered. The largest, Munich Re’s $300
million Muteki cat bond structured for Japanese insurer Zenkyoren, was a complete loss
for investors (AIR Worldwide 2011). The unprecedented losses from U.S. thunderstorms
and tornados in the summer of 2011 also triggered a total loss to American Family Mutual
Insurance Company’s $100 million Mariah Re cat bond, but investors have filed suit to
reclaim the capital, claiming that the company falsified its loss report (Trading Risk
2013b). Hurricane Sandy also precipitated smaller losses on several Swiss Re bonds that
have yet to mature.
These events have not discouraged investors’ interest in the high-paying risks,
however, and in industry circles many consider it fortunate that cat bonds were finally
hit with some high-profile losses. They suggest that the orderly default of bonds and
fulfillment of obligations to the original cedants would demonstrate the reliability of 167
cat bond protection to both risk cedants and insurance regulators, some of whom are
as yet unwilling to treat cat bond facilities as the equivalent of reinsurance when

SECURITIZED CATASTROPHE RISK


monitoring insurers’ capital adequacy. Investors are also cognizant that successful
payouts could improve the public image of cat bonds and those who invest in them.
Lewis (2007, 53) quoted one well-known dedicated cat fund founder, John Seo of
Fermat Capital Management, whose fund suffered major losses following Kamp Re’s
partial default from Hurricane Katrina: “I would be embarrassed if we had a big event
and our loss wasn’t commensurate with it. It would mean that we didn’t serve society,
[that] we failed society.” Although many may be skeptical of a hedge fund’s chief
executive claiming that his company aims to serve society, his comment nonetheless
challenges the opposite portrayal of cat bond investors as unprincipled speculators who
ultimately intend to leave insureds in the lurch, a concern articulated by Bougen
(2003), among others.
One of the subtexts of Seo’s comment is that such losses for investors are necessary
to maintain the vitality of bond issuance. Defaults caused by natural catastrophes thus
serve to discourage complacency about the risks involved, justifying and sustaining the
high returns that investors are paid for their risk taking. Or as one asset allocator for an
institutional investor explained to me in an interview in 2010, “If there is a big event that
we’re on the hook for, that’s ok, we’re not going anywhere. We’ve already earned enough
in the market since 2006 to make up for a one in 250 [year] event. The math is too
compelling to go running away when a cat happens.” This math remains compelling
precisely because catastrophic losses continue to occur. Without continuing catastrophic
damages, returns for investors fall because premium rates generally decrease and (re)in-
surance firms draw on internal capital or are able to access other reinsurers’ capital
cheaply. Returns were particularly high in the period following 2005’s Katrina, Rita, and
Wilma, when the institutional investment fund quoted above first entered the cat bond
market. Although various reinsurance firms, catastrophe modeling firms, and industry
associations differed in attributing the season’s record-breaking activity to anthropogenic
climate change or to a natural regime of variability known as the Atlantic Multidecadal
Oscillation, they agreed that regardless of the ultimate cause, the near future was likely
to hold more frequent and intense Atlantic hurricanes that would further deplete (re)in-
surers’ reserves. This anticipation of future losses—and the uncertainty about their
magnitude and frequency—kept rates higher in 2006 and 2007 (Johnson 2010). As I
ECONOMIC GEOGRAPHY

Volume of New Natural Catastrophe Bonds Issued, 1997–2011


8

6
Billions U.S. $

0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 3. Data provided by Guy Carpenter Securities. Following standard industry reporting
168 practices, monetary values have not been adjusted for inflation.

show later, this dynamic is a crucial reason why ILS market boosters frame climate
change as a major opportunity for the future expansion of the market.

Geographic Concentration and Recombination of “Peak Perils”


This analysis of the market’s temporal and geographic development begins with
market-wide totals and then proceeds to the dynamics of individual issuances over time.
For the purposes of establishing cumulative market size and analyzing trends, most
industry records date the beginning of the cat bond market to 1997 or 1998. Although a
few isolated issuances occurred prior to 1997, this is arguably the year in which the
market gained momentum and coherence as such. Figure 3 summarizes the volume of
new natural catastrophe bonds issued each year since then. From 1999 through 2004,
volumes hovered between roughly $1 billion and $1.5 billion, with new issuance of
between 5 and 10 bonds annually.9 Then in 2004, the North Atlantic hurricane season
brought four landfalling storms to the state of Florida within six weeks. It also logged
numerous meteorological records, including the strongest Atlantic storms ever observed
north of the 38th parallel or south of the 10th parallel, demonstrating the troubling
potential for changes in the patterns and locations of extreme events. By its unusually late
end in December, the season was the costliest on record at roughly $50 billion (unad-
justed) (Swiss Reinsurance 2004). Although this season did not provoke an immediate
“hardening” of reinsurance pricing in annual contract renewals, it retrospectively mag-
nified the market effects of the following season.
The year 2005 was infamous for hurricane Katrina, but it also featured two other
immensely destructive storms, Rita and Wilma, which made landfall in Texas and
Florida, respectively. Amid the season’s new meteorological records for the intensity and
frequency of storms, some reinsurers even speculated about the connection between

9
Note that this article includes only data on natural catastrophe securitizations linked to property insurance;
thus, the numbers presented here may be lower than accounts that include extreme mortality securitizations
of life insurance portfolios. For an analysis of how life and non-life securitizations are made fungible, see
Johnson (2013); for an exhaustive account of the vast array of insurance-linked securitizations, see Barrieu
and Albertini (2009).
Vol. 90 No. 2 2014

climate change and the season’s “never-ending loss records” (Munich Reinsurance 2006,
17). It was the most economically destructive season in history, yielding roughly $170
billion in total damages in the U.S. and neighboring countries, $69 billion of which were
insured (Swiss Reinsurance 2006). The result was a dramatic draw down of reinsurance
capital reserves and 76 percent higher average rates for U.S. property catastrophe rein-
surance during annual renewals in 2006 (Guy Carpenter 2006, 16).
The effects on the cat bond market were immediate and dramatic. In 2006, (re)insurers
sponsored a total of 28 bonds in an effort to access capital more cheaply than could be
had in traditional reinsurance and retrocession markets. The $4.7 billion of notes issued
in 2006 found an eager audience of investors hoping to take advantage of the high
post-disaster returns. These investors included multistrategy hedge funds, dedicated
catastrophe hedge funds, and even some institutional investors. The dramatic pile-on
continued in the following year with 27 bonds and the largest volume of issuance ($7
billion) in history. “Taking the development from 2004 to 2007 and using this as a basis
for further projections, some people had already forecast that capital markets would take
over traditional reinsurance” (Wallin 2010 n.p.).
The unfolding credit crisis in 2007 purportedly made catastrophe bonds appear more 169
attractive as an uncorrelated alternative asset class. In the spring of 2008, market boosters
were still giddily optimistic about the growth potential of ILS. Despite—and in fact

SECURITIZED CATASTROPHE RISK


because of—the subprime crisis and mounting troubles with securitized credit instru-
ments, the ILS market was buoyant. Broker-dealer Benfield (2008, 8) opined: “In fact the
credit crunch of 2007 highlighted the benefit of ILS as an uncorrelated risk and this,
combined with high returns from a relatively benign year for (re)insurance losses, has
confirmed the acceptance of ILS as an ‘alternative asset class’ leading to interest from a
wider spectrum of investors.” Eventually, the credit crisis made itself felt through default-
ing cat bonds and sell-offs in the secondary markets by highly leveraged hedge funds that
were desperate to raise cash. Four active cat bonds used Lehman Brothers as the
counterparty for the bonds’ collateral assets.10 Following the Lehman meltdown, five
months passed without the issuance of a single new cat bond (visible in the extreme
drop-off in Figure 3). The gyrations following the financial crisis precipitated changes in
the composition of the cat bond investor base, the staffing and management of banks’ ILS
desks, the form of collateral, and the mechanisms triggering bond payout. Nevertheless,
the fundamental form of the market appears to have survived; these changes reflect
attempts to refine the ways in which place-based risks are rendered investment-worthy in
the post-Lehman world. By mid-2012 the cat bond market finally returned to the volumes
reached at its height in 2007, but this long recovery time was not due to reticence from
investors. By mid-2010, dedicated cat funds and institutional investors were awash with
capital from maturing bonds and eager to buy. From the second quarter of 2011 through
the first quarter of 2012, investors’ interest was so large that 13 offerings were “upsized”
from their proposed issue amount, and in six cases sponsors sold at least twice the
volume originally planned (Lane and Beckwith 2012, 5).
Throughout these market swings, the geography of the underlying exposures securi-
tized through cat bonds has remained highly particular and relatively static. Figure 4a
and 4b presents the absolute and relative capital on risk by peril and location, following
broker Guy Carpenter’s six-part classification. Perhaps the most notable trend in these

10
Doing so jeopardized about $335 million of reinsurance coverage for U.S. hurricanes purchased by Allstate
and Munich Reinsurance, $100 million for California earthquake coverage purchased by Aspen Reinsur-
ance, and $225 million for U.S. earthquake and hurricanes purchased by Catlin Reinsurance (Trading Risk
2010b). All four bonds partially defaulted; losses totalled $116 million. (Trading Risk 2011b).
ECONOMIC GEOGRAPHY

170 b Relative Capital on Risk by Peril, 1997−2011


100%

80%

Other
60%
Japan typhoon
Japan quake
Europe wind
U.S. hurricane
40%
U.S. quake

20%

0%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Figure 4. Data provided by Guy Carpenter Securities. In Figure 4a, “bonds on risk” refers to all
bonds susceptible to losses in a given year; that is to say, they are between issuance and
maturation. Note that it is industry practice to tally the total principal of bonds covering two or
more perils (in which the entire principal is exposed to both perils) in all of the peril categories
they cover; therefore, the sum for each year exceeds the notional value of bonds on risk. Refer
to Table 1 for exact breakdowns of such recombinant issuances.

figures is the overwhelming and persistent concentration of capital in U.S.-based risks


and the decided lack of evening out to other risks and regions. In every year but one
(2003), combined U.S. hurricane and quake risks have absorbed more than 50 percent of
the total capital invested, and averaged over all 15 years their combined total is 67 percent
(37 percent hurricane, 30 percent quake). European wind risk comes in a distant third at
an average 14 percent, followed by Japanese quake risk averaging 10 percent.
U.S. hurricanes and earthquakes (and, to a lesser degree, European windstorms) are
known in industry parlance as “peak perils,” often preferred by many large investors
because of their higher returns. Peak perils refer to hazards that are linked to particular
geographic regions where the coupling of large insured property values and extreme
hazard results in large expected losses and accordingly higher costs of traditional insur-
Vol. 90 No. 2 2014

ance and reinsurance coverage. Because of this place-specific premium, cat bonds
covering peak perils generally offer investors the largest relative return per unit of risk.
Large institutional investors and multistrategy hedge funds are especially apt to focus on
the peak perils with the highest returns, since their assets are typically already widely
diversified. Contrary to some early suggestions that cat bonds could facilitate the provi-
sion of affordable coverage in regions outside reinsurers’ traditional markets, the years
following the 2008 crisis have seen a reconcentration of capital into peak peril regions.
Table 1 documents the sequence in which various regions and perils have been secu-
ritized through cat bond structures. Based on a data set of 197 publicly announced natural
catastrophe bond issuances from 1997 through 2011, the table provides an annual
breakdown of the region and monetary values of securitized perils. The “peril combina-
tion” categories listed in the table were developed by coding each tranche of every
issuance according to the perils and geographic locations that were securitized.11 The
progression of issuance detailed in the table make several dynamics apparent. The first,
which was noted earlier, is the continuing concentration of issuance in U.S. peak perils.
From 1997 through 2011, the total volume of bonds issued to cover stand-alone U.S.
hurricane risk ($7.9 billion) was by far the largest of any peril; it was followed by U.S. 171
hurricane plus quake ($4.7 billion); U.S. multiperil ($4.5 billion); California quake
($3.75 billion); and European windstorm ($3.75 billion).

SECURITIZED CATASTROPHE RISK


Second, as investors’ interest has grown, the parsing and selective recombination of
peak perils has resulted in an increasingly complex menu of securitizations. The temporal
development of such recombinations can be observed in the far left column of Table 1.
Most early offerings securitized exposure to a single peril in a single country or region.
Although the majority of these offerings have continued to be successfully issued
through the present, newer offerings have furthered the boundaries of synthetic
financialization by packaging together geographically and geophysically distinct risks.
This complexity is illustrated in offerings such as Swiss Reinsurance’s “Vega Capital”
cat bonds, issued in 2008 and again in 2010, in which $107 million of notes were equally
exposed to losses from U.S. hurricanes, quakes in California, windstorms in Europe, and
hurricanes and quakes in Japan.
Third, there has been a relatively small yet consistent florescence of alternative
offerings since about 2000. These combinations, usually grouped into one of the three
“other” categories in Table 1, have included bonds for Taiwanese, Mediterranean, and
Turkish earthquakes; cyclones and earthquakes in Australia and Mexico; and thunder-
storms in the United States. These “off-peak” perils are in demand by dedicated catas-
trophe hedge funds and ILS desks at reinsurance companies, which are often in need of
diversifying perils to offset large exposures in peak areas where their portfolios are
deemed “overweight.” Going forward, it is possible that off-peak perils could grow to
include new exposures in previously unsecuritized locations, particularly China, where
non-life insurance premiums grew 22 percent year-on-year in 2010 (Swiss Reinsurance
2010, 25).
These apparently countervailing demands for diversifying and peak perils fuel the
simultaneous extension of securitization to new locales and geophysical events and the

11
This coding generated 33 initial peril combinations, which were reduced to 23 using the following
conditions: peril combinations’ cumulative issuance had to be greater than $350 million, and each peril
combination had to be sold in at least three different years. Combinations that did not meet these
conditions were recategorized as “other multiperil,” “other quake,” or “other hurricane.” To portray recent
trends in recombination, new peril combinations developed in 2008 or later were included, regardless of
their cumulative volumes, provided that they had been issued at least twice.
172
Table 1
Annual Volume of Catastrophe Bond Issuance by Location and Peril Covered
Total for Peril Combination
Peril Combination 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (Millions U.S. $)

US Ha 395 450 280 417 150 219 58 180 0 1322 1828 370 950 881 417 7914
Cal Qa 112 0 0 150 265 474 386 323 0 698 619 0 375 0 350 3751
Jpn Qa 90 0 200 0 0 126 215 125 0 203 260 300 0 0 0 1519
US multia 30 90 46 0 0 0 0 0 176 228 1759 550 0 705 875 4458
Euro W 6 0 160 0 0 76 276 35 217 515 579 378 212 618 677 3748
Fla Ha 126 0 90 0 0 0 0 0 0 130 210 150 0 0 706
US H + Q 100 182 0 120 0 160 295 205 68 0 318 1016 1280 985 4728
Jpn Ha 80 0 0 0 0 0 0 0 200 120 0 0 0 0 400
US Q 100 0 0 67 59 0 300 490 138 0 14 350 0 1518
Euro W + Jpn Q 17 0 0 0 0 0 0 157 235 0 108 99 0 616
Other multi 483 150 0 278 0 405 100 465 0 68 170 0 2118
US H + Q + Euro W 162 0 0 0 200 30 75 0 0 0 150 617
US H + Euro Wa 120 0 0 0 100 0 0 0 0 150 250 620
US H + Q + Euro W + Jpn Q 258 8 100 63 0 200 200 0 0 100 929
US H + Cal Q + Euro W + Jpn Q 190 86 0 263 0 0 0 0 0 539
Other Q 100 0 75 0 125 0 0 0 0 300
US multi + Euro multi 250 0 125 0 0 0 0 375
ECONOMIC GEOGRAPHY

US H + Q + Euro W + Jpn H + Q 200 200 254 0 60 0 714


Mex Q 160 30 0 140 0 0 330
US H + Cal Q 60 0 0 210 0 305 575
Other Ha 110 0 150 80 0 340
US H + Cal Q + Euro W + Jpn H + Q 107 0 107 0 214
US Tstorma 100 0 100
Yearly Total 633 846 985 1139 967 1220 1730 1143 1991 4693 6996 2687 3392 4601 4109 37130
a
Designates perils with at least one new issuance in the first half of 2012.
Geographical identifiers: Euro = European, US = United States, Jpn = Japan, Cal = California, Fla = Florida, Mex = Mexico.
Peril identifiers: W = wind storms (typically European winter storms), H = hurricanes and typhoons, Q = earthquakes, Tstorm = thunderstorms, Multi = complex grouping of numerous
major and minor perils.
Source: Calculations by author, based on individual issuance data provided by Guy Carpenter Securities.
Vol. 90 No. 2 2014

fragmentation and recombination of risks from peak peril regions in a ceaseless search
for new risk-return profiles. The fragmentation and recombination of peak perils to create
hybrid multiperil, multiregion securities underscores that financialization is a selective
process that ties specific, often far-flung, places and geophysical events into circuits
through which finance capital can move, rather than “rolling out” evenly across econo-
mies and physical landscapes.

Why ILS? Accessing the Returns on Place


Creating a market in catastrophe bonds depends just as much on investors’ shared
perception of them as desirable assets as it does on the technical work of financial
engineering and catastrophe modeling that render them possible assets. How and why
insurance risk became a desirable alternative asset class for investors is the subject of the
second research question, to which this section turns. I suggest that the demand for cat
bonds has continued to grow because of the purposive, selective, and scalable relation-
ships that these instruments enable with fixed capital.
A telling comment from a pension fund manager overseeing many hundreds of
millions in ILS investments illustrates this transformation of investors’ perceptions. In 173
early 2010, we sat in a vaulted hotel lobby in Florida surrounded by marble and skylights,

SECURITIZED CATASTROPHE RISK


watching a group of trained ducks swim in a bubbling fountain. The manager used the
scene to illustrate the revelatory moment he realized the immense opportunities in the
ILS market. Gesturing around the interior, he reflected with wonder, “Once you realize
that all of this—everything you see!—is insured and reinsured . . . well, we started
realizing that there are billions and billions of dollars in premiums every year!” His team
was not alone. Throughout the mid-2000s, such realizations were multiplying across the
specialist investor community, from hedge funds to sovereign wealth to pension funds.
These investors are not simply attracted to the ILS market for the access it grants to
previously untapped or unintegrated sectors of the economy; after all, the story of tapping
new income streams could be told about virtually every alternative asset class. The ILS
market’s uniqueness lies in its ability to fashion geographic liabilities as strategic
resources, uniquely desirable because of their ontological disconnection from the behav-
ior of financial markets. New income streams—what may be called “returns on place”—
are derived by enabling purposive, scalable, and selective relationships with the
geography of the built environment and geophysical hazards. I consider each of these
relationships in turn.
First, given that the probability of loss on a cat bond is tethered in part to material
properties of the environment, rather than economic markets, cat bonds are often cham-
pioned as uncorrelated, or “zero beta” instruments. For instance, a dislocation in cur-
rency markets may ripple through commodities and financial derivatives markets, or
rising unemployment may have a knock-on effect on mortgage-backed securities, but
neither bears an ontological relationship to earthquake or hurricane activity. In modern
portfolio theory, beta denotes the correlation of an asset’s returns with the entire financial
market; high beta values indicate that an asset’s returns are highly sensitive to the
behavior of the larger market.12 Beta is also described as systemic risk—precisely the
culprit often blamed for the interconnected meltdown of the mortgage-backed securities
and credit derivatives markets in 2007 and 2008. Hence, a zero beta instrument holds
obvious allure.
12
Beta is an essential component of the Capital Asset Pricing Model, the dominant method for pricing
securities using modern portfolio theory. For an extensive account of the development of model and the
ways in which it and its users shape markets, see MacKenzie (2006).
ECONOMIC GEOGRAPHY

Media reports often attribute the majority of investors’ interest in cat bonds to the
purposive search for an uncorrelated asset class, particularly following the credit crunch
and financial crisis. From the simple perspective of returns, it was more or less the case
that cat bonds passed what one modeler called “the mother of all correlation tests,” the
financial meltdown of 2008. This is not to say that cat bond returns did not suffer, but they
weathered the financial storm in the fall of 2008 with higher values and less volatility
than either the S&P 500 or index portfolios of high-yield bonds. The relative success of
the catastrophe bond market in comparison to other equities is one of the primary reasons
why the ILS market continues to attract interest from “real money” (i.e., unleveraged)
funds, such as pension and sovereign wealth funds.
Nevertheless, the ILS market also demonstrates the impossibility of an entirely zero
beta financial product. Some correlation with the wider market is unavoidable due both to
ILS’s position as one of many alternative asset classes that share a common infrastructure,
and to the market’s shifting returns based on interest rates and (re)insurers’ cost of capital.
Prior to the collapse of Lehman Brothers, the ILS sector showed a 4 percent to 8 percent
correlation with the S&P 500; this correlation rose to 30 percent in the months following
174 September 2008 (Insurance Insider 2009). Even if one considers only a bond’s loss
exposure independent from its financial structuring, wider economic conditions may
influence human behaviors that drive total losses. These behaviors include the propensity
to file claims, exaggerate claims, litigate, or commit insurance fraud. An ILS consulting
firm thus stated in a retrospective analysis of the correlation around the financial crisis:
“going forward the correlation is not going to be as low as the 4 percent prior to Lehman,
ever. We anticipate [it] will settle . . . in the mid-teens” (Lane 2009, 16).
Despite these inevitable correlations, the ILS market’s credentials as a relative diver-
sifier multiply due to the second advantage of scalability. Among one of the common
drawbacks of many alternative asset classes are the relatively small size of individual
offerings and the limited total capacity for investment. This drawback makes it difficult
for institutional investors who are trying to invest large volumes of funds; high transac-
tion fees and the piecemeal nature of deals can scuttle otherwise attractive alternative
investments. “The beauty of cat bonds,” the manager of a large fund explained, “is that
you can put $500 million in!” In 2010, for example, State Farm issued a $250 million
U.S. multiperil cat bond, the entirety of which was purchased by a single multiasset
manager, thought to be the Ontario Teachers Pension Plan (Trading Risk 2010a).
Finally, insurance-linked securities allow investors to engage with place-based risks
selectively and opportunistically, rather than invest in either the insurance or reinsurance
industries as a whole. This approach avoids the recalcitrant problems of (re)insurers’
capital structure and the material encumbrances of their sales networks. In the traditional
market for catastrophe coverage, reinsurers typically expend resources to maintain offices,
sales personnel, and long-term underwriting relationships with insurers. Such ties also
prevent reinsurers from abandoning relatively unrewarding risks. One multiasset invest-
ment manager bluntly summarized: “I’ll probably always have a heavy tilt towards Florida
wind because that pays the most. Reinsurers, on the other hand, continue writing business
like Australia wind that pays them 1 percent or something like that. Those are stupid risks
at shitty returns. Why make fixed capital investments when I don’t have to? Reinsurers in
some sense do have to in order to maintain offices, clients, networks. But we don’t have to.”
By comparison, because cat bond contracts are written for particular regions and
perils, they allow investors to select risks that are based on geography and relative
return—a much more enticing prospect than investing the same capital in a reinsurer that
is bound to underwrite less profitable risks. The same manager articulated this rationale:
“Where the reinsurance market is broken is in its capital deployment abilities. It’s crazy
Vol. 90 No. 2 2014

to keep betting the same odds if the price you’re getting paid for it is going up and down.
How much you bet on heads should change based on how much you’re paid for it in a
cyclical market.”
Commentators and fund managers often use the metaphor of “accordion capital” to
describe the injection of funds from the capital markets into ILS when reinsurance capital
is scarce and rates are high and the subsequent removal of these funds when returns fall
below those available in other sectors. The influx of this capital is sometimes credited for
the dampening of reinsurance price cycle amplitudes beginning in the early 2000s,
visible in Figure 5 in the reduced spread between the peaks and troughs of pricing cycles.
The opportunistic dynamics of such accordion capital have profound implications for
how and with what effects the capital markets “access” climate change risks. This is the
focus of the next section.
Some preliminary conclusions about the dynamics of catastrophe risk securitization
and its position within the political economy of the (re)insurance industry can be made.
Despite the rhetorical formulation of the “convergence” of insurance and capital markets,
transferring risks from one market to the other is useful only insofar as the two have not
entirely converged. Rather than convergence, this relationship may be more precisely 175
called “interdigitation.” Such interdigitation allows strategic access to risks and their
recombinations, rather than undifferentiated mixing. Currently securitization is used

SECURITIZED CATASTROPHE RISK


selectively, according to the degree to which particular geographic, economic, and
geophysical characteristics make a set of risks (1) regionally concentrated with high-
value exposures, (2) readily modeled, (3) in excess of the ceding company’s desired risk
profile in the region, and (4) not cheaply insurable through traditional reinsurance or
retrocession coverage. Placements of securitized risks in the capital markets are thus
highly contingent on competitive pressures and the cost of capital in reinsurance and
financial markets more generally.
As was demonstrated in the previous two sections, ILS capital maintains a fundamen-
tally ambivalent relationship to geographic space; on the one hand, cat bonds commodify

Figure 5. The “rate on line” refers to the relative price the buyer pays for a given amount of
coverage. Because the expected losses–and thus risk prices–for different perils and regions can
be vastly divergent, industry reports typically use an index to chart relative price movements
instead of calculating a single market-wide average rate on line. Source: Guy Carpenter &
Company (2011).
ECONOMIC GEOGRAPHY

risk by tying it to absolute space and geophysical nature, while on the other hand, they
facilitate a strategic avoidance of the material encumbrances and associated costs of less
profitable places and business relationships maintained by (re)insurers. This cleaving
allows investors to access place-based premiums and risks—returns on place—without
requiring them to take on the fixed costs required to originate those premiums. The
remainder of the article follows the principle of maximizing “returns on place” to its
logical conclusion and suggests that efforts to write catastrophe bonds to capitalize on
growing climate change risks are a cause for concern.

“Underwriting to Securitize” Climate Risks?


The Stakes of Securitization
This section turns to the third research question to explain why ILS market actors
consistently frame the impacts of climate change in terms of “opportunity”, and to
examine the implications of securitization for risk mitigation and climate change adap-
tation. It argues that the sector’s self-consciously drawn parallels with mortgage-backed
176 securities and credit derivatives give reason to doubt that cat bonds in their current forms
will effectively distribute or reduce the risks of climate change. Although proposals for
“underwriting to securitize” suggest that this practice could expand coverage for under-
insured vulnerable regions, the dynamics of ILS investing identified earlier in the article
instead suggest maladaptive outcomes that may ultimately increase the industry’s depen-
dence on the state as an insurer of last resort.
A brief review of the expected impacts of climate change on extreme events provides
the context for this argument. Because the relationship between average climate condi-
tions and extreme events is nonlinear, even a small change in the former can lead to large
shifts in the frequency of the later. The IPCC fourth assessment report concluded that
climate change is “very likely” (>90 percent probable) to increase the frequency of
extreme precipitation and heat waves in the future, and suggests that rising sea levels will
generate greater storm surge from tropical cyclones (Solomon et al. 2007, 52). Extreme
flooding and drought records that have been set over the past decade provide evidence to
support these projections (Coumou and Rahmstorf 2012). The future behavior of tropical
cyclones is of particular importance for the cat bond market, since such a large propor-
tion of bonds are exposed to hurricane risks. Although recent efforts to downscale IPCC
simulations to fine-grained resolutions (Knutson et al. 2010) project that the global mean
frequency of tropical cyclones is likely to decrease between 6 percent and 34 percent by
the end of the 21st century, they suggest that proportionally more of these storms will be
very intense (categories 4 and 5). They also project a 2 percent to 11 percent increase in
the mean global maximum wind speeds of tropical cyclones and about 20 percent more
rainfall in the center of the storms (159–161).
Catastrophe fund managers consistently represent climate change as a preeminent
business opportunity for the cat bond market, which they say will benefit from the
growing demand for new products to hedge climate risks. There is disagreement over
what proportion of the existing growth in insured catastrophe losses, particularly to
hurricanes, can be attributed to climate change in comparison with rising property values
and coastal population growth (Pielke et al. 2008; Crompton, Pielke and McAneney
2011).13 But regardless of the current attribution, many (re)insurers have warned that

13
An exhaustive review of current studies on tropical cyclones and climate change written by 10 leading
scholars in the field concluded that “it remains uncertain whether past changes in tropical cyclone activity
Vol. 90 No. 2 2014

increasing climate-related losses in the future will eventually result in higher rates (cf.
ABI 2004; Munich Reinsurance 2006; Geneva Association 2009; Schwierz et al. 2010,
among many others; see Johnson 2010).
The potential for higher premiums and the promise of a greater demand for insurance
in a changing climate keep ILS boosters optimistic about the prospects for market
growth. These possibilities constitute ILS capital’s “ecological fix” (Bakker 2009),
which was reflected in the epigraph with which this article began, a comment made by
the managing principal of the prominent cat fund Nephila Capital: “climate change could
be a major driver for growth in the insurance and reinsurance industry, but only if prices
change to reflect the changing risk. . . . Over the long term, it presents more of an
opportunity than a threat” (Schauble, quoted in Kent 2010, n.p.). Higher (re)insurance
rates on line would drive even greater competition from alternative sources of risk
financing that are able to provide equivalent coverage for lower—yet still very
remunerative—rates. As was demonstrated in the previous section, price undercutting
from the capital markets is possible because of the high fixed costs built into the
(re)insurance business.
Thus the cat bond market’s exposure to changes in extreme events has perhaps 177
ironically become another item in a growing list of financial qualities that recommend it.
Hedge fund manager John Seo enumerated the strategic attraction of cat bonds to the

SECURITIZED CATASTROPHE RISK


Financial Times: “[A cat bond is] credit insensitive, has little to no interest-rate duration,
is neutral to an inflation view and boosted by increases in climate change impact”
(quoted Kelleher 2011, n.p.). Because pricing on bonds typically responds quickly to
changing market conditions—including recent catastrophic losses and seasonal forecasts
for hurricane activity (Lane 2010)—investors could redeploy capital to take advantage of
near-term profit opportunities if decisive evidence of the growing climatic volatility
emerged for a particular region. The pace at which financial capital can move into and out
of these markets is quickened through secondary and derivatives market trading in “live
cats” and “dead cats” as potential loss events develop. These instruments present further
possibilities for opportunistic investors to engage in spatial and temporal circuit switch-
ing (although in practice, the lack of liquidity in secondary markets can prevent this
switching). Trading on live cats—typically limited to weather perils whose development
can be monitored and forecast over several days—allows real-time hedging and specu-
lation on whether a tropical cyclone will develop into a damaging landfalling hurricane,
for instance. Dead cat trading can apply to nearly any peril and is based on buyers’ and
sellers’ estimations of whether an event in the recent past is likely to generate losses large
enough to trigger a payout on a given bond. The opportunistic possibilities of climate
change for investors reach beyond simple circuit switching, since some market boosters
and economists actively promote the expansion of cat bond offerings in response to
increasing damages from extreme events.
In certain circles, cat bonds are being framed as a financial fix for the political failure
to develop solutions to mitigate and adapt to climate change. This echoes what Grove
(2012) has termed the “financialization of disaster management.” This figuration was
exemplified in a special issue of the Geneva Papers on Risk and Insurance, published in
2008, in which insurance executives and economists discussed how the insurance indus-
try should best address climate change risks (Chemarin and Picard 2008). A number of
authors speculated on how growth could be kick-started in the ILS market particularly to

have exceeded the variability expected from natural causes” and that “detection of an intensity change of
a magnitude consistent with model[ed climate] projections should be very unlikely at this time” (Knutson
et al. 2010, 157, 160; see also Emanuel, Sundararajan, and Williams 2008).
ECONOMIC GEOGRAPHY

address increasing damages in a changing climate. In one contribution entitled “Extreme


Events, Global Warming, and Insurance-Linked Securities: How to Trigger the ‘Tipping
Point,’ ”, Michel-Kerjan and Morlaye (2008, 165) suggest that ILS market players should
“think creatively,” drawing on the growth model of credit derivatives, which they lauded
as “one of the most successful stories in recent capital market developments” (see also
Charpentier, 2008). The authors—and market boosters in general—share the assumption
that expanding underwriting capacity through ILS is a self-evidently desirable goal.
It is difficult to ignore the parallels between ILS and mortgage-backed securities and
credit derivatives markets, especially since market boosters deliberately invoked these
similarities before the full extent of the subprime meltdown and credit crisis became
clear. For instance, the chief financial officer of primary insurer Zurich Financial Ser-
vices confidently suggested: “the process of [asset-backed] securitization has contributed
to the recent transformation of the banking industry, and we should ask ourselves
whether the banking model (“originate to securitize”) could be valid for insurers too”
(Wemmer 2008, 1). The insurance equivalent of such a banking model would entail
“underwriting to securitize.”
178 Although the resemblance of ILS to mortgage-backed securitization is not exact,
paradoxically it may be becoming more so. Unlike mortgage-backed securities, in which
the ownership of a future income stream from a specific individual loan was sold onward
to be “sliced and diced” in combination with thousands of other mortgages, thus far cat
bonds have not transferred the ownership of the premium income stream or the claims-
payment responsibility for an individual insurance policy. These rights and responsibili-
ties have always remained with the ceding (re)insurance firm. Nevertheless, the demand
from the investor side suggests that such transformations may not be far off. In a
broker-sponsored roundtable on the future of ILS, hedge fund manager Seo articulated
his hope that (re)insurers would use cat bonds to expand capacity, rather than simply to
shift the same pieces of risk around: “Everybody [in (re)insurance] manages their risks
so that they don’t have any unhedged exposure. . . . Through their own self-imposed
discipline, they’re covered. But if the cat bond gives them the chance to expand their
capacity and pass it into the cat bond facility . . . that could be very interesting . . . we
need more bonds like that” (Aon Benfield 2010). This is an argument for creating cat
bond structures that would encourage insurers and reinsurers to underwrite new business
expressly for the purpose of securitization—a further step toward true “convergence” of
the capital markets with (re)insurance. In the process, new kinds of previously uninsur-
able risks and regions would ostensibly become insurable.
This logic bears a troubling resemblance to that used to rationalize the mortgage-
backed securitization politically. Consumers’ access to debt financing from capital
markets was hailed as allowing a previously excluded segment of the population to
become homeowners, while more efficiently spreading risks through capital markets
(Ashton 2009; Wyly et al. 2009). Much as the financing of consumer debt was a tem-
porary “solution” to the problem of stagnating income and rising inequality in the United
States from the 1970s onward (Rajan 2010; Blackburn 2006), cat bonds are emerging as
a temporary financial fix for the political failure of climate governance.
It is now clear that the practice of originating to securitize—in which mortgages were
locally originated and globally distributed to investors—also encouraged an unparalleled
construction boom, drove the U.S. and U.K. real estate bubbles to astronomical heights,
and propagated their subsequent implosion through far corners of the global economy
(Aalbers 2009, Martin 2011). Although the securitization of consumer debt arguably
concealed the problem of rising inequality from public view for some time, ultimately it
greatly exacerbated the phenomenon. Meanwhile, hundreds of billions of dollars in
Vol. 90 No. 2 2014

bailouts for banks that were deemed too big to fail amounted to a massive transfer of
wealth from households and governments to financial capital.
Although retrospective analyses of the financial crisis have the benefit of hindsight, the
present research was conducted midstream as discussions of “writing to securitize” were
unfolding. Thus, it is unclear how insurance-linked securitization of climate risks will
proceed. This should become a priority for future research. At this point, I can only make
inferences on the basis of the market dynamics identified here.
If cat bonds and ILS products in general do reach a “tipping point” of the kind some
seek, in which underwriting to securitize climate risks becomes a principal strategy for
insuring vulnerable landscapes, the prospects for climate-appropriate development and
adaptation would seem dim. If high yield is a function of high risk, then it is credulous
to imagine that ILS instruments will ever systematically encourage less risk taking. As I
demonstrated in the second section, the cat bond market is characterized by the highly
segmented and stratified provision of coverage in which “peak perils” attract an inordi-
nate amount of the total capital that is invested. There is no reason to expect that this
dynamic will change fundamentally.
Hence, investors’ ongoing interest in high-paying peak perils could ironically make 179
more capital available for paying claims, rebuilding, and new underwriting in places like
Miami, Florida, where the highest concentrations of value are being made even more

SECURITIZED CATASTROPHE RISK


vulnerable by climate change. This point recalls the asset manager’s admission (in the
third section) that “I’ll probably always have a heavy tilt towards Florida wind because
that pays the most . . . . How much you bet on heads should change based on how much
you’re paid for it in a cyclical market.” There is some evidence that other investors share
this rationale. A 2012 analysis of returns and expected losses found that although the
expected return on a market-weighted average portfolio of cat bonds was twice as large
as the previous year, investors were also taking on much higher risks of extreme losses
in the tail of the modeled loss distribution (Lane and Beckwith 2012). Following this
trend, it seems likely that investments in the sector will initially increase as investors are
paid more to assume growing climate risks. At the time of this research, market partici-
pants still appeared to operate under the assumption that “the market will decide” where
the shifting boundary between tolerable and intolerable risks—or productive and
destructive ones—lies.14 The question is how far this trend can proceed before this
boundary is crossed, and what the consequences of such a breech would be.
If writing to securitize results in insurers relaxing their own “self-imposed discipline”
and taking on unhedged exposures, as Seo suggested, it could initially encourage the
provision of new policies for lower rates or under relaxed terms. The incentive for
insurers to keep claims low would logically decrease, and with it, current underwriting
practices that are meant to encourage microadaptive behaviors by policyholders may also
disappear. Examples of the latter include premium discounts for loss-mitigation mea-
sures, such as installing storm shutters, elevating foundations, or reinforcing structural
elements of buildings (cf. Ward, Herweijer, Patmore, and Muir-Wood 2008). Meanwhile,
the cat bond market’s ability to undercut reinsurance pricing acts as a structural impedi-
ment to reinsurers’ purported power to enforce climate-sensible development via higher
pricing for riskier areas (cf. Herweijer, Ranger, and Ward 2009).
In such a scenario, a cluster of major weather-related catastrophes triggering bond
defaults could have a dramatic effect, prompting investors to retreat from these landscapes
if they were they found to have become more risky than originally thought. (Again there

14
Thanks to an anonymous reviewer for framing the issue in these terms.
ECONOMIC GEOGRAPHY

is a more than passing resemblance to the panic witnessed in the credit crisis of 2007–08.)
Primary insurers who suddenly found themselves without investors willing to buy their
bonds might then become dependent on the state as an insurer of last resort. As Ericson and
Doyle (2004a, 2004b) have pointed out, the insurance industry typically reveals its uneasy
dependence on the financial apparatus of the state in times of uncertainty and crisis:
Insurers are eager to gamble on uncertainties as long as they keep reaping profitable returns.
However, an extraordinary catastrophic loss leads them to hop on the pass-the-exposure
express and seek refuge until they can restructure the market and gain confidence that they will
again be on the winning side. The refuge is provided by governments, who help underwrite
faltering insurance markets. This socialism for business enterprise can supersede any social-
izing effects on behalf of the insured (Ericson and Doyle 2004b, 169).
Although the authors based this description on the behavior of (re)insurers following
the September 11 terrorist attacks, their conclusion has broader applications, given how
well it describes the behavior of financial capital following the subprime crisis. In cases
of extreme crisis, the entire financial services industry depends on state intervention to
180 provide an economic backstop, either through direct infusions of capital—the bailout
model—or by acting as an insurer of last resort—the subsidy model. The ultimate
economic burden is devolved to taxpayers on the one hand, and sovereign debt markets
on the other. The market in securitized geophysical risks is unlikely to prove an exception
to this rule.

Conclusion
This analysis of the catastrophe bond market has enumerated the drivers and impli-
cations of the securitization of fixed capital’s place-based vulnerabilities. I have dem-
onstrated how parts of (re)insurance markets have been rendered investment-worthy for
financial capital through enabling purposive, scalable, and selective engagements with
insurance risks. This securitization pathway allows mobile capital on a search for yield
to reframe spatial liabilities as tradable assets, thus accessing new “returns on place.”
Although the search for new risk-return profiles has fueled the simultaneous parsing and
recombination of risks from peak peril regions and the extension of securitization to new
locales and geophysical events, the geographic footprint of cat bond investments remains
extremely uneven and concentrated on peak perils in the United States and, to a far lesser
degree, in Europe and Japan.
Investors’ continued interest in the ILS market hinges on the articulation of a funda-
mentally ambivalent relationship with geographic space. Although the commodification
of catastrophe risks requires tying financial capital to absolute spaces, the high rates of
return on catastrophe bonds are possible only because these instruments enable financial
capital to avoid the fixed costs and relational entanglements borne by (re)insurers. This
selective engagement with catastrophe risks is exemplified in investors’ reformulation of
the impacts of climate change on extreme events as new growth opportunities.
Recent proposals to underwrite new insurance policies with the express intention of
securitizing them have hypothesized that the cat bond market could parallel the expan-
sion of asset-backed securities and credit derivatives in the 2000s. Documenting the
effects and outcomes of these proposals is a task for future research. But if catastrophe
bonds share much in common with other alternative assets like residential mortgage-
backed securities, then the similarity of the risks posed by these instruments to particu-
larly vulnerable places and populations should give us pause. As Christophers (2009,
821) has pointed out with respect to asset-backed securitization and credit derivatives,
“the more institutions there are passing finite amounts of money back and forth, with
Vol. 90 No. 2 2014

each such institution determined to extract its own return on capital, . . . the greater the
cumulative demand that is obviously made on that finite money—requiring greater risks
to be taken to sustain returns while underlying markets are rising, and leading to
significantly more (and more widespread) damage when those markets collapse.” In the
case of cat bonds, the same search for yield that leads investment to concentrate in
high-paying peak peril regions could make more capital available for rebuilding and new
underwriting in areas where high concentrations of value are becoming even more
vulnerable to extreme events. Incentivizing post-catastrophe rebuilding in peak peril
areas would magnify the peaks and troughs of preexisting uneven development rather
than dampen them. In this context, if a series of major catastrophes then prompted
investors to retreat, the state would find itself an insurer of last resort for a built
environment that had ironically become less adapted to climate extremes. If securitiza-
tion discourages climate-appropriate adaptation and development, the end result may be
landscapes that are even more vulnerable than those of today.

Aalbers, M. 2008. The financialization of home and the mortgage market crisis. 181
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