Matthew C Klein, Columnist

Is Your Pension Courting Catastrophe?

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

October 28, 2013 at 7:35 PM UTC

Matthew C. Klein writes for Bloomberg View about the economy and financial markets. He previously wrote for the Economist magazine and its economics blog, Free Exchange. Before that, Klein was a research associate at the Council on Foreign Relations, where he spent more than two years studying the history of the Federal Reserve and the intellectual history of monetary economics for an upcoming book by Sebastian Mallaby. He also worked at Bridgewater Associates, where he studied the economies of Central and Eastern Europe and advised institutional investors on asset-liability management. Klein has a bachelor's degree in history from Yale University. Originally from Chicago, he lives in New York.

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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.