The catastrophe bond market experienced record-breaking growth in 2024, exceeding $50 billion in total market value as insurers sought to transfer increasing climate-related risks to private investors.
Table Content:
- A Deeper Dive into the Catastrophe Bond Surge
- Allstate’s Record-Breaking Cat Bond Deal
- Attractive Returns Amidst Rising Interest Rates
- Market Dynamics and Future Outlook
- Fitch Ratings on the Hardening Reinsurance Market
- Shifting Focus to Secondary Perils
- Challenges and Investor Preferences
- The Growing Significance of Secondary Perils
- Conclusion: A Record Year and Future Uncertainties
This unprecedented growth was fueled by a surge in catastrophe bond issuance, reaching $17.7 billion – a 7% increase from the previous record set in 2023, according to Artemis, a leading provider of insurance-linked securities market data. This figure encompasses cyber-risk and private transactions.
A Deeper Dive into the Catastrophe Bond Surge
Tanja Wrosch, head of cat-bond portfolio management at Twelve Capital AG, characterized the cat-bond market’s performance as “another year of strong growth.” She emphasized the importance of larger, more diverse, and deeper markets for the success and sustainability of cat-bond solutions and investment strategies.
Catastrophe bonds offer investors attractive returns in exchange for assuming insurance market risks associated with natural disasters. In the event of a predefined catastrophic event, bondholders face potential losses; however, if no such event occurs, they can earn substantial double-digit returns.
Several factors contributed to the increased issuance of cat bonds in 2024. Rising inflation significantly impacted rebuilding costs for properties damaged by storms and other catastrophic events, prompting insurers to seek alternative risk transfer mechanisms. Concurrently, insured losses have been on an upward trajectory due to the increasing frequency and severity of extreme weather events fueled by climate change.
Allstate’s Record-Breaking Cat Bond Deal
Illustrative of this trend, Allstate Corp. recently finalized a $650 million catastrophe bond deal, the second largest in its history, securing reinsurance protection against storms, wildfires, and other natural perils. Notably, this deal surpassed its initial target by approximately 86%, as reported by Artemis.
Attractive Returns Amidst Rising Interest Rates
Despite the inherent risks, catastrophe bonds continued to outperform many fixed-income assets in 2024. Investors are projected to earn returns of 16%, although slightly lower than the record 20% achieved in 2023.
The yield on a catastrophe bond comprises a risk spread and the prevailing money-market fund rate. Investors benefited from both attractive risk spreads and higher money-market yields ranging from 4.5% to 5%, a significant increase from the near-zero rates observed during the pandemic.
Market Dynamics and Future Outlook
The catastrophe bond market witnessed significant fluctuations in risk spreads throughout 2024, primarily driven by shifts in capital availability. Wrosch highlighted the growing influence of these market dynamics relative to underlying risk fundamentals. Twelve Capital anticipates a risk spread between 5% and 7% for the upcoming year, compared to a peak of 8.4% in 2024, according to Artemis data.
Looking ahead to 2025, Wrosch projects “high single-digit to low double-digit gross returns” for cat-bond investors, a sentiment echoed by analysts at Plenum Investments AG.
Fitch Ratings on the Hardening Reinsurance Market
Fitch Ratings, in a November report, corroborated the favorable risk-adjusted returns experienced by investors since 2022, attributing them to a hardening reinsurance market characterized by increasing premiums, stricter underwriting criteria, and reduced coverage capacity.
Shifting Focus to Secondary Perils
Traditionally, catastrophe bonds have served as shock absorbers for rare but highly damaging “tail events.” However, insurers are increasingly seeking to utilize these securities to mitigate rising losses from more frequent, less severe hazards like wildfires and thunderstorms. Although individually modest in impact, these events can accumulate significant insured losses.
Challenges and Investor Preferences
While models for assessing “secondary perils” have improved, they lack the reliability of earthquake or hurricane models, creating challenges in accurately calculating risks. The willingness of cat-bond investors to embrace bonds covering aggregate losses, rather than single-occurrence events, remains uncertain. Wrosch confirmed a prevailing investor preference for “occurrence structures” at Twelve Capital.
The Growing Significance of Secondary Perils
Despite investor preferences, the surge in aggregate losses from secondary perils presents a critical challenge for the insurance industry. Twelve Capital estimates that non-peak disasters, such as wildfires, tornadoes, and floods, will account for the majority of insured losses from natural catastrophes in 2024, exceeding $50 billion. The firm suggests that the frequent and substantial losses from tornadoes and hail may represent a “new normal.”
Conclusion: A Record Year and Future Uncertainties
The catastrophe bond market concluded 2024 with record-breaking issuance and total market value, driven by insurers’ need to manage escalating climate-related risks. While attractive returns and a hardening reinsurance market fueled investor demand, the increasing significance of secondary perils and evolving investor preferences pose challenges and opportunities for the future of this dynamic market. The ability of the cat bond market to adapt to these evolving risks will be crucial for its continued growth and sustainability.
