Catastrophe Bond [ILS]

Catastrophe bonds (cat bonds) are insurance-linked securities that transfer natural disaster risks from insurers to capital markets investors. If a specified catastrophe occurs (hurricane, earthquake, pandemic), investors lose principal, which pays insurance claims. Otherwise, investors receive high yields compensating for risk. For example, a $500 million cat bond covering Florida hurricanes might pay SOFR + 800 basis points but loses principal if a Category 4+ hurricane causes $2 billion+ in insured losses. Triggers include indemnity (actual insurer losses), parametric (physical event measurements like wind speed), modeled loss, or industry loss indices. Cat bonds provide insurers with additional capacity beyond traditional reinsurance, particularly for peak risks. The $40 billion cat bond market grew significantly post-Hurricane Katrina. Investors value cat bonds for portfolio diversification since natural disasters are uncorrelated with financial markets. Sophisticated catastrophe modeling by firms like RMS and AIR underlies pricing. COVID-19 tested pandemic bonds, with World Bank’s pandemic bonds triggering payments. Climate change increases both demand and uncertainty in cat bond markets.