It seems catastrophe bonds aren’t the only way to hedge a cat. According to BusinessWeek, hedge funds are directly insuring catastrophes:

Collectively, though, hedge funds have huge sums available for catastrophe protection. That means much more hedge money is likely to flood in if rates remain high. Among the funds that have already entered the sector are Kenneth C. Griffin’s Citadel Investment Group in Chicago, George Soros’ Soros Fund Management, HBK Investments in Dallas, and Louis M. Bacon’s Moore Capital Management.

How Hedge Funds Are Taking On Mother Nature, by Peter Coy, BusinessWeek, 16 January 2006

This is partly a result of Hurricane Katrina in 2005. The article says it is different than what happened after Hurricane Andrew, the previous most costly hurricane, in 1992.

Why do hedge funds do this?

They’re betting on rare risks remaining rare:

For insurers, the hardest risks to price are the greatest disasters, because there’s little experience to draw on. That’s where hedge funds, with their appetite for risk, are making the biggest difference, says Albert J. Pinzon, a senior partner in the law firm of Mound Cotton Wollan & Greengrass in New York, who works with hedge funds. Last year a pioneering hedge fund committed itself to pay one insurer $10 million in the seemingly unlikely event of two hurricanes in one season each costing the industry $10 billion or more, according to Enda McDonnell, CEO of Access Reinsurance Inc. in Westfield, N.J., who brokered the deal. The premium for the policy was $600,000. But after the payout was almost triggered in 2005, the quoted premium has soared to $1.5 million. The increase might have been even bigger without the added participation of hedge funds, McDonnell says.

So hedge funds are also taking advantage of insurers’ lack of quantification of the likelihood of such big risks. Better quantification would reduce everyone’s risks.

Hm, that sounds like the Internet. What is the actual risk of a worst-case worm, anyway?

-jsq