Insurance companies already have a track record transferring extreme mortality risks to the capital markets. This is normally done by issuing a special kind of catastrophe bonds, called extreme mortality bond. These bonds pay a higher coupon in exchange for insuring the risk of a catastrophic increase in deaths due to a pandemic or plague. Should a certain threshold of deaths above the average materialise, interest and/or capital will be foregone for investors and paid out to the insurance company. According to an October 2008 report by Guy Carpenter, there are around USD1.5 billion of such bonds outstanding. However this is only a drop in a bucket since estimates are that in case of a full-fledged pandemic it could cost US life insurance alone between USD31 billion and USD133 billion, says Reuters.

Despite the outbreak of swine-flu the outstanding cat bonds have not shown any great price reaction. The main reason for this might be that in order to be triggered millions of people have to die which currently - thank God - does not look very likely. Additionally the outstanding mortality bonds cover only the United States, Britain, Canada, France, Germany and Japan.

So the possibility of insurance companies being hit by a pandemic seems very low since a lot of people would have to die first. But what about the travel companies, that feel the pain immediately? Shares in companies like Lufthansa (LHA), Thomas Cook (TCG), Accor (AC), Iberia (IB) and others suffered immediately from booking cancellations, health warnings and possible travel restrictions. These companies are not hedged against pandemics and other catastrophes such as terrorism except for the normal insurance policies. Cat bonds and other insurance linked securities might be cost efficient, long-term new hedging universe still to be tapped by such companies. Travel companies would benefit by issuing cat bonds from long-term insurance without the need to renegotiate every year the terms. Cat bonds issued by tourism enterprises could be triggered by events like travel restrictions, sudden fall in passenger numbers, orders to ground aircrafts such as during 9/11 and other similar incidents.

Another advantage of using cat bonds in general is that since being also some kind of securitisation and alternative risk transfer (ART) they have learned from the errors made by other securitisation vehicles, such as CDOs, RMBS etc. The latest cat bond structures have implemented increased transparency provisions and other safeguards (for more information see article “How state guaranteed bonds can help to free up capital in insurance companies” at HedgeFund-Lawyer.com) in order to allow investors an adequate assessment of risk. In addition to this, insurance for the travel industry is a sector well studied by legions of actuaries which would increase the acceptance of travel companies cat bonds by the capital markets.

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