Catastrophe Call

"Hello, is Bob there? Oh, hey Bob. Yeah, we just had a 9.3 Richter quake." Okay...that's one kind of catastrophe call. But there's another kind, though it's about as obvious. Just a different type of "call."

It's a stipulation in a bond that allows the issuer to “call” the bonds if the project being financed is hit by a natural disaster (or catastrophe). Catastrophic calls come up in municipal bonds. The catastrophic call option gives the municipalities protection against disasters that hit their projects (like road construction) and prevent the project from generating revenue.

You’re the mayor of a town (congratulations!). You want to build a toll bridge for the town, but the town’s budget doesn’t allow for that kind of expense. So, you issue 20-year revenue bonds to pay for it. A few years later, the bridge collapses due to a tornado.

Obviously, no more revenue will be collected and you will have no way to pay back the bonds. But, the bonds included this catastrophe call, and the tornado qualifies, so you are able to pay off the investors at their par amount, even though the 20 years isn’t up. The investors miss out on the years of interest, but it does work to the town’s advantage, because the town is able to pay them off and call it a day, rather than have to make the interest payments on a bridge that isn't there.