#628
Trading Tail Risk
Published:
Feb 07, 2026
Author:
Sarah Parsons Wolter
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Insurance markets have long struggled with the “unknown unknowns.” But as frontier artificial intelligence scales toward capabilities once consigned to science fiction, some thinkers are proposing a capital-markets solution borrowed from natural disasters: catastrophe bonds.
Catastrophe bonds have for decades let insurers transfer extreme risks (hurricanes, earthquakes, floods) to global capital markets: investors earn coupons in exchange for bearing losses if a predetermined trigger occurs. Now, commentators suggest structuring AI catastrophe bonds to cover the tail risk of rare, high-severity AI failures that conventional underwriters won’t touch. In essence, an AI firm could spin up a special-purpose vehicle and issue bonds whose principal is put at risk only if a pre-defined AI catastrophe event occurs. Investors would receive attractive yields for carrying that tail, while insurers and reinsurers avoid absorbing exposures they can’t model or price.
The challenge is real: AI risk events, unlike earthquakes, lack historical data for underwriting and are likely highly correlated with broader market stress. Still, by making AI’s tail risks tradable, catastrophe bonds could turn an opaque liability into a priced, regulated instrument. If AI’s biggest threats are systemic, the only way to hedge them may be to put them on a ledger.
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