Potentially Risky Bond Offerings: Bowie, Catastrophe, and Death Bonds - dummies

Potentially Risky Bond Offerings: Bowie, Catastrophe, and Death Bonds

By Russell Wild

When rock star David Bowie decided in 1997 to produce his own bonds using his considerable talent (and future song royalties) as collateral, it struck some as a rocking good idea. Bowie got $5.5 million out of the deal, but some investors haven’t fared as well as they thought they would.

Here are a few types of bonds that fall a few notes shy of being totally safe investments but nonetheless may make a reasonable addition to some people’s portfolios.

Rocking with Bowie Bonds

David Bowie was the first artist to issue bonds using his future royalties as collateral. The bonds, issued in 1997, carried a coupon rate of 7.9 percent. Not too shabby. But in 2004, given some changes in the music industry, including the advent of file sharing on the Internet, Moody’s downgraded the bonds to junk status.

The price of Ziggy Stardust’s bonds fell to earth. Those who needed to sell lost a good deal. But the concept of Bowie Bonds — raising cash with talent — caught on nonetheless, and other artists soon followed.

What are Bowie Bonds?

Since the original Bowie Bonds (sometimes called Pullman Bonds after David Pullman, the financier who pulled the Bowie deal together), other artists have followed suit. James Brown, The Isley Brothers, Iron Maiden, Ashford & Simpson, and Rod Stewart all closed similar deals, raising cash with bonds backed by future song royalties.

The music-makers get their money up front, and bondholders get to collect interest (they hope). Similarly, a few small bond issues have been backed by future revenues of Hollywood film sales and a handful of sporting events.

Should you invest in Bowie Bonds?

These are all very modest bond issues, rather illiquid (meaning that you may not be able to sell your bond), and backed by assets of wavering value. Bond manager Marilyn Cohen, who knows the bond world inside and out, wisely suggests that if you do buy a Bowie-type bond, at least try to find a rocker in the grave! That way you know he or she is beyond scandal.

Cashing in on catastrophe bonds

Call it strange, but in past years several billion dollars have poured into bonds that pay higher-than-market rates of interest, but only if the weather cooperates.

What are they catastrophe bonds?

Catastrophe bonds are issued mostly by insurers, pay juicy rates of return, and are backed by revenues from true moneymakers. That may sound great, but here’s the catch: The issuer reserves the right to use the cash behind the bonds if a hurricane or tsunami or tornado or earthquake results in many people suddenly making claims against the insurance company.

If the catastrophe results in massive claims, bondholders can wind up seeing their principal cast into the wind.

In November 2010, for example, insurer Mariah Re Ltd. issued a $100 million, three-year “U.S. tornado catastrophe bond” on behalf of American Family Mutual Insurance Company. The bond paid 6.25 percent — or, more accurately, it promised to pay that amount.

In late 2011, following a year of heavy twister activity, Mariah defaulted on the bonds. Investors lost everything to the tornadoes, just as Dorothy’s aunt and uncle lost their Kansas farm — only it wasn’t a dream. The bonds became worthless.

Should you invest in catastrophe bonds?

Are you kidding? A few extra dollars in possible interest in exchange for risking your principal? No way. That’s not what bonds are all about — or should be about. These bonds may possibly make sense for institutional buyers with huge resources but not for mere mortals who hope to retire someday and live on more than peanut butter sandwiches.

Dealing in death bonds

If catastrophe bonds weren’t morbid enough, some of the world’s biggest insurance companies have begun to issue death bonds. You stand to gain higher-than-market rates of interest, but only if a certain number of people don’t die.

You read that right.

What are death bonds?

Death bonds are somewhat similar to catastrophe bonds. The bonds are issued by insurers and pay raucous rates of interest, but the insurer reserves the right to tap the money behind the bonds if more people than expected die. Some of these bonds directly tie your return to the death rates of a pool of the insured.

If the insurance company’s customers eat their vegetables, wear their seatbelts, and don’t play with guns, you win. If an epidemic strikes or a volcano erupts, you lose, and your investment may turn to ash.

American International Group has pushed other strange bonds lately, which may also be called death bonds, “blood pools,” or “collateralized death obligations.” These bonds are backed by insurance policies on the elderly, and they pay off when the insured dies. It’s sort of the opposite of the more traditional death bond.

So far, AIG has been having a hard time pushing these bonds, as the major ratings agencies have refused to play along.

Should you invest in death bonds?

Yuck. These investments are both risky and morbid. As with the catastrophe bonds, institutional investors may have some reason to take a risk on such a thing. For living, breathing individuals, these bonds make little to no sense.