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Matthew C Klein

Is Your Pension Courting Catastrophe?

Pensions seeking to boost returns have been buying more and catastrophe bonds. They, and regulators, should be careful.

One of the best ways to blow yourself up in financial markets is to sell lots of cheap insurance against risks you don't fully understand. Traders call this "picking up pennies in front of a steamroller," since the strategy appears profitable right up until you lose everything.

It's therefore somewhat concerning to read, per Bloomberg News, that pension funds are attempting to boost their returns by putting more money in catastrophe bonds and other insurance-linked securities. (The pension plan for Ontario's teachers, which is renowned in the industry for its size, savvy and aggressiveness, has been trading catastrophe bonds for years.) While their involvement in the market is still small compared to the specialty investors that currently predominate, pension funds could end up creating systemic risk by distorting the price of insurance and exposing savers to large losses.