Catastrophe Bonds offer insurance against certain natural calamities. The issuer pays a very high rate of interest on the bonds, but keeps the principal if a disaster strikes. Thus, such bonds behave in a fashion similar to insurance contracts, with a big payout if an insurable event occurs. The interest payments are akin to premium payments.
Catastrophe bonds have covenants stating explicitly that payment of interest and repayment of principal will be eliminated forever if a specified disaster strikes. Thus, do not confuse them with debt relief, debt whose payment as been forgiven voluntarily by creditors in the wake of a crisis such as the earthquake in Haiti.
According to the article "When calamity strikes" in the 1/23/10 issue of The Economist, 80% of such bonds issued in 2009 protected against risks in the United States. However, the World Bank has begun to assist less-developed nations in tapping this market, notably with a $290 million issue in October 2009 on behalf of the Mexican government.
