Insurance-Linked & Risk Markets

Cat Bonds (ILS)

Insurance-linked securities for yield.

Investment Overview

Catastrophe bonds (cat bonds) transfer insurance risk from insurers to capital market investors, offering 5-10% yields with zero correlation to stocks/bonds. Investors receive high coupons (SOFR + 4-8%) but lose principal if catastrophe trigger occurs (e.g., Category 4+ hurricane hits Florida, 8.0+ magnitude earthquake in California). Market size: $40B cat bonds outstanding (2024), part of $100B+ insurance-linked securities (ILS) market. Leading investors: Pension funds, endowments, hedge funds (Fermat Capital, Plenum Investments). Returns: 5-7% annual average (1997-2023) with occasional -5 to -10% years when hurricanes/earthquakes trigger losses. Diversification benefit: 0.0-0.2 correlation with S&P 500.

Market Context & Trends

Cat bond market grew from $5B (2005) to $40B+ (2024) as institutional investors sought uncorrelated returns. However, climate change increasing frequency/severity: 2017 hurricanes (Harvey, Irma, Maria) triggered $10B+ cat bond losses; 2011 Japan earthquake triggered $3B. Result: Pricing increased 2018-2024, with cat bond yields reaching 8-10% (vs. 5-6% pre-2017). Key development: Parametric triggers (wind speed, earthquake magnitude) enable faster payouts vs. indemnity triggers (actual insurer losses) which take years to settle. Most cat bonds 1-3 year duration, reducing interest rate sensitivity vs. traditional bonds.

How to Invest in Cat Bonds (ILS)

Stone Ridge Reinsurance Risk Premium Fund: $5B+ AUM, diversified cat bonds, $25K minimum (accredited)

Plenum Cat Bond Fund: Bermuda-domiciled, global perils, $50K minimum (accredited), quarterly liquidity

Fermat Capital ILS Funds: $1.5B AUM, cat bonds + collateralized reinsurance, $100K+ institutional

Hannover Re Cat Bond Index: Not investable but industry benchmark (5.5% annual 2002-2023)

Public reinsurers: RenaissanceRe (RNR), Everest Re (RE) own cat bonds (indirect exposure, dividends 2-4%)

Key Platforms & Access Points

Stone Ridge: Largest retail-accessible cat bond fund, $5B+ AUM, 5-7% historical returns, -8% in 2017

Plenum Investments: Bermuda fund, institutional quality, quarterly redemptions (subject to gates)

Fermat Capital: $1.5B AUM, emphasizes downside protection via diversification and conservative underwriting

Public reinsurers (RNR, RE): Own cat bonds as part of reinsurance operations, offer dividend exposure

Artemis Cat Bond Fund Index: Tracks cat bond performance, research tool (not investable)

Key Investment Metrics

Trigger probability: Catastrophe models estimate 1-5% annual probability; higher = higher coupon

Attachment point: Loss level triggering payout; higher attachment = lower trigger probability = lower yield

Perils covered: US hurricanes (30% of market), earthquakes (25%), European windstorms (20%), other (25%)

Expected loss: Modeled annual loss as % of principal; 2-5% typical cat bonds

Historical trigger rate: 3-5% of cat bonds trigger annually (industry average 1997-2024)

Risk Considerations

Understanding these risks is critical before investing in cat bonds (ils).

Catastrophe trigger: Single major event (Category 5 hurricane, 8.0+ earthquake) can cause 50-100% principal loss
Climate change: Increasing frequency/severity raises loss probabilities beyond historical models
Model risk: Cat models (RMS, AIR, CoreLogic) may underestimate risk; 2017 losses exceeded forecasts
Correlation in tail events: Multiple bonds trigger simultaneously (2017: three hurricanes within 6 weeks)
Liquidity: Cat bonds trade OTC; forced sales face 20-40% discounts; funds may gate redemptions

Related Investment Opportunities in Insurance-Linked & Risk Markets

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