Investors pile in to cat bonds despite very active hurricane season

by Gautam Naik

After emerging from an unusually active hurricane season with market-beating returns, catastrophe bonds are rapidly adding investors.

Despite the increase in extreme weather — 2024 marked the ninth straight season in which the Atlantic basin suffered above-average storm activity — catastrophe bonds have proved highly resilient. This year, they’re on track to return about 16%, after delivering a record 20% in 2023.

“We’ve had two fantastic years,” said Dirk Schmelzer, senior fund manager at Plenum Investments AG, a Zurich-based firm that specializes in insurance-linked securities. And that’s “attracted new money,” he said.

Plenum estimates that the volume of catastrophe bonds in funds marketed under Europe’s UCITs label has risen roughly 49% since the end of 2022 to $13 billion at the end of September. That’s as overall issuance for 2024 looks set to hit a record $16.5 billion, according to Artemis, which tracks the insurance-linked security market. 

Insurers issue the bonds to pass on risks associated with extreme natural disasters to the capital markets. Investors are then called on to cover losses if a predefined catastrophe occurs, but stand to be richly rewarded if it doesn’t. Interest in the securities has been rising as climate change and urban development redraw the insurance map. Artemis estimates the total cat-bond market is now worth about $48 billion, including private market transactions.

Schmelzer said the key reasons why returns aren’t quite as high this year as they were in 2023 are the decline in Treasury rates and the rise in investor demand, which is allowing issuers to price their bonds at slightly better terms.

It’s “automatically put a little pressure on cat-bond spreads,” he said in an interview. Yields slipped from almost 14% at the end of May to about 10.3% at the end of November, according to Plenum.

Schmelzer said investors should expect “high single-digit to low double-digit returns” in 2025 unless there’s a major market shock.

Plenum said its defensive UCITS cat-bond fund, which has about $400 million of assets, generated a 12% return so far in 2024. Its dynamic fund, with about $210 million of assets, gained about 15%.

Over the past two years, holders of cat bonds have seen the average expected loss rate drop to as low as 2% from an average 2.5% during the previous three years, according to Fitch Ratings. And it now takes a bigger catastrophe to meaningfully dent returns, a development that’s reflected in the increase of what’s known as the attachment point, which is the threshold at which a bond triggers and investor capital starts covering insured claims.

This year is set to be the hottest on record, with the average global temperature soaring to 1.62C above pre-industrial levels in November, according to the European Union-backed Copernicus Climate Change Service. That’s coincided with an unusually high level of destructive storms, with Hurricanes Beryl, Helene and Milton, as well as Super Typhoon Yagi standing out among the most devastating.

Swiss Re AG estimates that insured losses from natural catastrophes will likely exceed $135 billion in 2024, marking the fifth consecutive year in which the $100 billion threshold has been breached. 

“Much of this increasing loss burden results from value concentration in urban areas, economic growth and increasing rebuilding costs,” said Balz Grollimund, head of catastrophe perils at Swiss Re. “By favoring the conditions leading to many of this year’s catastrophes, climate change is also playing an increasing role.”

Top insurance companies suffered $10.6 billion of climate-attributed losses this year, which the group Insure Our Future notes is just shy of the $11.3 billion of direct premiums they underwrote for commercial fossil-fuel clients in 2023. 

Higher temperatures are supercharging so-called secondary perils such as wildfires and severe convective storms. SCSs alone are expected to add more than $50 billion to insured losses this year, after accounting for a record $70 billion in 2023, according to Swiss Re.

Investors in catastrophe bonds weren’t called on to cover any losses caused by Hurricane Beryl, and a lot of the impact of Helene and Milton was flood-related, which meant cat-bond investors were largely unaffected. 

“There were a number of strong hurricanes that made landfall, but as they didn’t directly hit major metropolitan areas, the impact on the reinsurance and cat-bond markets is likely to be muted,” Twelve Capital AG, a Zurich-based cat-bond investor, said in a Dec. 4 update about the market.

Jeff Davis, partner and portfolio manager at Elementum Advisors, which manages about $4 billion of insurance-linked securities, said it’s now clear 2024 is “setting up to be the second-best year in the market’s history” for investors in cat bonds. And “now that spreads have come down, sponsors are buying more coverage.”

Meanwhile, specialist cat-bond fund managers are seeking to avoid exposure to secondary perils. These are aggregate rather than single-event shocks like a hurricane, and are proving much harder to model. For insurers, however, perils such as thunderstorms, wildfires and floods now pose the biggest risk. 

“We are seeing a bit more of a shift to aggregate transactions,” Elementum’s Davis said. But there’s “not enough comfort” about how secondary perils are modeled for investors to want such exposure, he said.

Plenum’s Schmelzer said he’s aware of efforts by issuers to add secondary perils to the catastrophe-bond market. But “we tend to underweight them,” he said.

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