Cat Bond Boom Faces Risks from Underestimating Secondary Disasters
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Cat bonds have produced excellent returns recently, attracting more investors, but the models used to price risk may underestimate losses from secondary perils like storms and wildfires.
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Secondary perils now cause more insurance losses than major disasters, but cat bond models were designed around pricing single huge events like earthquakes.
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Investors are moving away from cat bonds covering aggregate annual losses, where secondary risks are most likely to lead to shortfalls.
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There is limited historical data to model secondary perils, and they are difficult to analyze when bundled with major disasters.
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If losses keep rising while models underestimate secondary risks, some investors may lose confidence in cat bonds.