Social Policy Bonds and Catastrophe Bonds

An anonymous reader of this blog pointed out that Social Policy Bonds are very similar to Catastrophe Bonds or 'Cat Bonds'. Catastrophe Bonds are mainly used as a form of insurance. They are issued by a body, such as an insurance company or local government, that stands to lose if a specified catastrophic event occurs. The issuers typically pay fixed payments unless the event occurs - which helps the issuer to meet the cost of insurance claims. In return, cat bonds pay more interest and have a lower rating than an issuer's other bonds. Apart from their higher yield they are attractive to investors because their riskiness - the risk of a catastrophe occurring - is uncorrelated with other market risks.

Catastrophe Bonds are therefore primarily an insurance concept. They're not designed to make people avert any specified catastrophic event, which so far I think are exclusively natural disasters such as hurricanes or earthquakes. In that respect they differ from Social Policy Bonds. It's interesting that the Social Policy Bond concept has been in the public arena for about 17 years: I have spoken about it on numerous occasions at think tanks, universities and once at OECD in Paris, but nobody before now has brought Catastrophe Bonds to my attention.

The two concepts diverge when we change the nature of the specified event to something that can be averted quite readily, or when the redemption funds grow to such a size that it's worth investors in the bonds doing something about avoiding or mitigating the results of even a natural event such as an earthquake.