Investors embrace ‘cat’ bonds

Catastrophe bonds come of age

Facing a growing price tag from intensifying hurricanes, wildfires and severe storms, the insurance industry has turned increasingly to whizzy financial tools that give investors an opportunity to bet on where climate disasters will materialise — and to profit when they don’t.

The insurance industry now routinely faces loss years of more than $100bn — a number that captures only insured assets. In recent years, uninsured losses have cost communities hundreds of billions of dollars more.

To help finance these growing losses, insurers have turned to so-called catastrophe or “cat” bonds. This year cat bonds, which insurers use to shift some of the cost of large disasters to bondholders, have been issued at a record pace as part of a wider push into insurance-linked securities.

The growth of these products has increasingly given alternative asset managers a way to take the other side of the climate change bet. These groups use funds that ultimately flow from investors, such as pension funds, family offices and endowments, to buy instruments that can provide higher yields than traditional fixed-income offerings such as government bonds.

But as ILS issuance has grown they have attracted more scrutiny, including from sceptics who warn that these tools could make insurance markets more volatile.

Insurance brokers, who help companies and governments buy insurance, are largely delighted with a trend they say has helped rein in the soaring cost of cover.

Without a “massive” influx of alternative capital of about $70bn after 2015, reinsurance costs would have been higher, David Flandro, head of industry analysis at Howden Re, told Moral Money.

Issuance of cat bonds surpassed $18.1bn in July, according to specialist data provider Artemis, compared with a record issuance of $17.7bn for the whole of 2024.

Investors collect income from the bonds so long as disaster doesn’t hit. If a disaster does occur, some or all of the principal can be diverted to cover insurance losses. Investors favour these products since their returns can be less correlated with the broader financial cycle than many other high-yielding investment products.

Traditionally, the largest reinsurance houses have managed outlier events for insurance companies by diversifying their exposures to the world’s costliest disasters.

Companies such as Munich Re and Swiss Re can balance their exposure to a Japanese earthquake, for example, against a Florida hurricane, a terrorist attack in France, or a cyber attack in the UK.

Reinsurers have taken note of the increased cat bond issuance by insurance companies — and have warned about potential risks that could be building up within the market, as alternative investors crowd in on their turf.

Some argue that capital markets investors, like hedge funds, aren’t in it for the long game and could rapidly withdraw from insurance markets, which could send the cost of cover soaring.

Others in the reinsurance industry protest that catastrophe bonds often take a “remote” slice of risk — signing up to cover only the least-likely-to-occur perils, and paying out last — and meanwhile collecting a steady drip of premiums.

Some of this consternation sounds a bit like reinsurers being peeved that new competitors could be beating them at their own game.

After January’s record-breakingly expensive California wildfires, for example, primary insurers and the state’s insurer of last resort scheme absorbed the largest losses. Traditional reinsurers took a smaller hit, and ILS structures, which had relatively low exposure to wildfire, were largely unaffected.

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