Catastrophe Corelation & the Trouble with Terrorism Bonds

Where there are moneyed sorts, there is usually a market (even if incumbents don’t want it). Such is the case in terrorism insurance, where incumbent reinsurers typically won’t insure for chemical, biological, radiological and nuclear attacks (CBRN, in the insurance vernacular).

As will come as no surprise to anyone with experience in capital markets, the unwillingness of incumbents to insure had led to a movement to float … terrorism bonds. No, these are not money-raising tools for Osama and his band. Instead, they are securities whose proceeds would be used for insuring against terrorist strikes, thus mitigating their impact and helping all of us in the extremely unhappy (and unlikely) event of a CBRN attack.

A good and idea around which you could raise considerably capital, right? Well, maybe not. The attraction of most catastrophe bonds (earthquakes, hurricanes, etc.) is that in all but the most extreme outlier instances they are uncorrelated with other economic events — like, say, a swoon in capital markets. Such would not be the case with a sizable CBRN attack, which would almost certainly cause a collapse in equity markets.

The upshot: While terrorism bonds sound bad they are actually just a variant of a typical catastrophe bond — albeit a catastrophe bond with the unhappy property of being highly correlated with other securities. Darn.


  1. Martin Tibbitts says:

    Hmm…I think we would be entering dangerous territory if we were to create a bond that a terrorist could short…thus financing his own terrorism.
    Martin Tibbitts