Catastrophe bonds — as the name may suggest — aren’t for fledgling investors. Even so, these high-yield, high-risk securities are attracting growing interest as natural catastrophes intensify.

First developed for the US market in the 1990s, cat bonds are issued by governments, insurers, or reinsurers to cover the costs of natural disasters. Investors buy the instrument in the hope that a payout won’t be triggered, meaning they’ll get their money back plus a return. Alternatively, in the case of a bond-triggering natural disaster, the issuer will keep the capital to cover the fallout.

“From the perspective of insurers and reinsurers, cat bonds provide access to an alternative source of capital that is more flexible than on-balance sheet capital and can be targeted towards absorbing specific types and layers of risk,” said Brandan Holmes, VP-senior credit officer at Moody’s Ratings. “Cat bonds can also be more cost effective than traditional reinsurance,” he told Euronews.

The appeal of these securities has gained prominence in the wake of recent disasters like Jamaica’s Hurricane Melissa. Crucially, capital markets provide nations with a vital means to lower insurance costs at a time when aid spending in rich countries is dropping. Repeated natural disasters can push governments into insurmountable debt, particularly as the cost of servicing those dues becomes higher.

From an investor perspective, the instrument also has its perks. Not only do the bonds carry attractive yields because of their risky nature, they provide portfolio diversification because of their limited correlation with financial markets. This means that when stocks and typical bonds fall at the same time — an uncommon but real scenario — catastrophe bonds offer some protection. “They also tend to have relatively short maturities which provide investors with flexibility in asset allocation decisions,” said Holmes.

Complex trigger conditions

According to data firm Artemis, the outstanding value of the global cat bond market is around $57.9 billion (€49.93bn). Despite the growing climate risk, these assets also saw historically strong returns in 2023 and 2024, reaching 20% and 17% respectively.

One factor boosting returns is that investors only pay out if certain conditions are met. For example, when Hurricane Beryl hit Jamaica last year, the nation failed to get any cat bond coverage when air pressure failed to drop below a certain threshold. On the other hand, in the wake of this year’s Hurricane Melissa, Jamaica will receive a full payout of $150 million (€129.37mn) thanks to its World Bank catastrophe insurance.

Analysts stress that the complex conditions surrounding cat bonds make the product unsuitable for inexperienced investors. “You have to have a really good understanding of the risk passed on,” said Maren Josefs, credit analyst at S&P Global. She added: “What we’ve also seen recently is investors presuming they are investing in extreme events, like a really big hurricane or earthquake. But over the last few years, mid-sized events such as tornadoes, wildfires, or floods have been happening with greater frequency, meaning some investors were surprised when they lost money to these sorts of natural disasters.”

Institutional investors are currently the key purchasers of cat bonds. However, there are ways for retail investors to gain indirect exposure to the product. Earlier this year, the world’s first ETF (exchange traded fund) investing in cat bonds made its debut on the New York Stock Exchange, meaning fund managers can now pool investor contributions to buy cat bonds. In the EU, the instruments aren’t easy for non-professionals to access, but indirect exposure is possible through UCITS, a type of mutual fund.

“The actual cat bond that gets issued, there’s no way that either a US or EU retail investor can just buy that,” said Johannes Schahn, an associate at Mayer Brown who advises on debt issuance. “They’re only offered to qualified investors,” he continued, “but what has been happening occasionally is that mutual funds invest or partially invest in cat bonds.”

ESMA weighs in

Despite the perks of these securities, their availability may be further restricted in the EU in the coming years. This comes after a report from the European Securities and Markets Authority (ESMA), sent to the European Commission this summer, advising that cat bonds shouldn’t be included in UCITS. The market watchdog clarified that UCITS should only hold a small indirect exposure of up to 10% to these instruments.

While ESMA’s recommendation has ignited conversations around the risks of cat bonds for non-professional investors, Kian Navid, senior policy officer for investment management at ESMA, told Euronews that the advice sent to the Commission wasn’t passing a value judgement on the investments. “It is not that ESMA’s technical advice takes a position against retail investors accessing cat bonds per se. The advice is not about outlining what constitutes a good or bad investment, but it provides data and risk analyses for the European Commission’s consideration,” he explained. “However, conceptually, if you opened up UCITS to alternative assets (like cat bonds) beyond 10%, that would risk blurring the lines between UCITS and alternative investment funds (AIFs).”

A decision from the Commission is still pending, and this will involve public consultations and further market analysis in 2026. Even so, it remains to be seen whether catastrophe bonds will appeal to European tastes.

“It’s a product that is established in the US market and less so in Europe,” said Patrick Scholl, partner at Mayer Brown. “I don’t know if there are many interested investors here… But if we see more catastrophe-driven developments in the region, we might see more of these products in Europe.”