Catastrophe bonds (cat bonds) have reached an all-time high this year, with the total market surpassing $50 billion, as insurers seek new ways to manage escalating risks from climate-related disasters.
Sales of these specialised bonds, which provide coverage for extreme weather events such as hurricanes, earthquakes, and wildfires, rose 7% to $17.7 billion in 2024, according to Artemis, a market tracker for insurance-linked securities.
Insurers and investors are increasingly turning to cat bonds as the financial cost of climate change continues to grow, pushing insured losses to unprecedented levels.
Inflation and climate change boost insurer reliance on cat bonds
Rising inflation and more frequent weather extremes are driving insurers to expand their reliance on cat bonds.
Reconstruction costs have surged, leaving insurers exposed to higher payouts when disasters strike.
At the same time, climate change has intensified secondary perils like wildfires, tornadoes, and hailstorms.
Twelve Capital, a Zurich-based investor, estimates that secondary perils will account for most of the $50 billion in insured losses this year, highlighting a shift away from peak events like hurricanes.
Despite the growing market, challenges remain. Secondary perils are harder to model compared to established risks like earthquakes, making it difficult to assess potential losses.
This uncertainty has led many investors to favour bonds tied to single-occurrence events, such as a Florida hurricane, over aggregate loss structures.
Allstate Corp. showcased the growing scale of the market with its $650 million cat-bond deal this year, the second-largest in its history.
The agreement provides reinsurance against storms, wildfires, and other natural perils, marking an 86% increase over the company’s initial target.
Such deals underscore the growing appetite for catastrophe-linked securities as insurers seek to transfer risk in a volatile environment.
Investors reap high returns amidst hardening insurance market
Cat bonds continue to offer attractive returns, outperforming many fixed-income assets. In 2024, investors are projected to earn returns of 16%, following a record 20% yield in 2023.
The yield on these bonds combines a risk spread with the prevailing money-market fund rate, which has climbed to between 4.5% and 5%—a significant rise from near-zero levels during the pandemic.
Sharp fluctuations in risk spreads this year have added a layer of complexity.
These changes often result from sudden shifts in capital availability rather than underlying risk factors.
Analysts expect risk spreads to stabilise at 5%-7% in 2025, compared to highs of 8.4% earlier this year.
Fitch Ratings attributes the sustained demand for cat bonds to hardening reinsurance markets, which are characterised by higher premiums, tighter underwriting criteria, and reduced coverage capacity.
With these favourable conditions, cat-bond investors can expect returns in the high single digits to low double digits next year, according to Twelve Capital and Plenum Investments.
Insurers are increasingly using cat bonds to mitigate losses from frequent, smaller-scale hazards such as wildfires and thunderstorms.
While these events may have modest impacts individually, their cumulative effect can result in significant losses.
As the insurance industry adapts to a changing risk landscape, catastrophe bonds are playing an increasingly vital role in managing both peak and secondary perils.
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