A few days ago, New York’s Metropolitan Transportation Authority (MTA) announced it is selling a “catastrophe” bond worth $125 million, in order to cover the damage from future natural disasters.
The New York City transportation system has a 109-year-old history, but it has “never faced a disaster as devastating” as Hurricane Sandy, the chairman of the MTA, Joseph J. Lhota, said in a statement. After Sandy smashed the city in October 2012, the “Metro-North Railroad lost power from 59th Street to Croton-Harmon on the Hudson Line and to New Haven on the New Haven Line. The Long Island Rail Road evacuated its West Side Yards and suffered flooding in one East River tunnel. The Hugh L. Carey Tunnel is flooded from end to end, and the Queens Midtown Tunnel also took on water and was closed.”
The bus and subway system suffered a $4.8 billion hit from Hurricane Sandy last year, and the catastrophe bond “will be able to offload the risk of incurring similar storm-related losses to investors, who will receive a yield in return for agreeing to pick up future repair bills.”
Catastrophe bonds, also known as “Cat bonds,” are designed to spread risk. In 1992, Hurricane Andrew caused damage totaling nearly $25 billion. The insurance companies were staggered by the huge cost. Since then, people have started to pay attention to the cost of natural disasters, such as storms and earthquakes, that can cause huge losses of property and life. Therefore, the cat bond has emerged as a way to spread risk and loss as a conditional payment to the bondholders. The condition is the bondholders will not be payed if the catastrophe occurs; but if nothing occurs, the insurer will return the principal plus the interest. Normally, the cat bond interest is higher than the market rate of return of other bonds.
Traditionally, insurance companies cover storms, earthquakes and other natural disasters. They try to transfer risk through reinsurance. Reinsurance companies often negotiate with insurance companies to set a deductible agreement, and the reinsurance company will pay the amount exceeding the deductible.
The bus, subway, railroads, area bridges and tunnels are like the blood vessels and arteries of the greater New York area, and Grand Central Terminal is the heart of the entire transportation system. The Museum of American Finance has within its collections a $1,000 New York Central Railway Company 4 1/2% bond that also served New York’s transportation system over 100 years ago. This bond was issued in 1952 by the New York Central Railway Company, founded in 1852. The American Banknote Company printed it, and the vignette is an engraving of Grand Central Station.
Interestingly, the due date of this mortgage bond is October 2013! Coincidentally, at about the same time an historical bond centered around the New York transportation system is coming due, a new type of bond for the transportation system has become necessary.