In an AI blow-up, would insurance pay out?

In 1912, tailor and inventor Franz Reichelt ascended to the first level of the Eiffel Tower to demonstrate a suit designed as both clothing and a parachute. After initial failures with mannequins, he attempted a manned test, tragically falling to his death. Today, credit-default swap (CDS) investors find themselves in a precarious situation, akin to Reichelt's fate, as they attempt to navigate the complex world of artificial intelligence (AI) and the associated financial risks.

CDSs, which can be used for hedging or speculation, gained notoriety during the 2007-09 global financial crisis and the subsequent euro-zone debt crisis. In 2011, a Greek debt restructuring failed to trigger CDS payouts, leading to a loss of investor confidence. This trend continued in 2014 when Portugal's central bank split Banco Espirito Santo, rendering old CDS contracts ineffective for the stronger offshoot.

Despite these setbacks, CDSs have made a comeback, particularly due to growing concerns over France's public debt and the rising costs of insuring against potential defaults in the AI sector.

Investors are now grappling with the complexity of AI-related financing arrangements, which often involve various debt structures such as data-center leases and "remaining performance obligations." As these arrangements become increasingly intricate, the likelihood of non-payment rises, potentially triggering CDS payouts. However, the unpredictable nature of these restructuring events mirrors the unpredictable parachute jumps that Reichelt attempted, leaving many investors uncertain about the merits of CDS investments in today's rapidly evolving financial landscape.