status: draft

Catastrophe bonds

Catastrophe bonds are 144A or Reg S securities where principal is at risk if a specified catastrophe event occurs. You receive a coupon (SOFR + spread) for bearing the risk that a hurricane, earthquake, or other catastrophe will trigger a loss of principal.

How cat bonds work

The basic structure is straightforward:

Sponsor (cedent) forms an offshore SPV (typically Bermuda or Cayman)
SPV issues notes to investors under 144A or Reg S
Investor principal goes into a collateral trust
Sponsor pays premium to the SPV
If a trigger event occurs, collateral pays the sponsor
If no trigger event, investors receive principal back at maturity plus earned coupon

The SPV is bankruptcy-remote from the sponsor. If the sponsor fails, investors still have their collateral.

Typical deal sizes

Size	Classification	Characteristics
$75-150M	Small	First-time issuers, niche perils
$150-400M	Standard	Repeat issuers, single peril
$400-750M	Large	Diversified sponsors, multi-tranche
$750M+	Jumbo	Major cedents, often multi-year programs

Pricing components

Component	Typical Level	Who Pays
Risk spread	200-1500 bps	Sponsor to SPV
Collateral return	T-bill/SOFR	Collateral account
Structuring fee	0.25-0.75% upfront	Sponsor
Management fee	5-15 bps annual	Sponsor

Illustrative pricing. See pricing disclaimer.

Maturity options

3 years: Most common, balances execution cost with sponsor hedging needs
4-5 years: Growing, particularly for cedents seeking longer-term capacity certainty
1-2 years: Rare in bond form, more common in sidecar or collateralized reinsurance

Risk metrics

Three metrics define cat bond risk. You need all three to understand what you own.

Probability of attachment (PoA): The likelihood of any principal loss during the risk period. A bond with 2% annual PoA has roughly a 1-in-50 chance of experiencing some loss each year.

Probability of exhaustion (PoE): The likelihood of total principal loss. For a $100M bond, this is the probability you lose the entire $100M. PoE is always lower than PoA because partial losses are more common than total losses.

Conditional expected loss (CEL): Expected loss given that attachment occurs. CEL = Expected Loss / PoA. A bond with 3% expected loss and 5% PoA has a 60% CEL, meaning if it triggers, you lose 60% of principal on average.

Worked example

Metric	Bond A	Bond B
Expected loss	2.5%	2.5%
Probability of attachment	3.5%	5.0%
Probability of exhaustion	1.8%	1.5%
Conditional expected loss	71%	50%
Spread	550 bps	500 bps
Multiple	2.2x	2.0x

Both bonds have the same expected loss, but Bond A has lower attachment probability with higher severity if attached (wider layer, bigger losses when triggered). Bond B triggers more often but with smaller average losses (narrower layer). Which is better depends on your preference for frequency vs. severity risk.

Spread multiples

The spread multiple over expected loss (spread / EL) is the key pricing metric.

Expected Loss	Typical Spread	Multiple	Profile
0.5-1.0%	200-400 bps	3.0-5.0x	Remote risk, senior attachment
1.0-2.0%	300-550 bps	2.5-4.0x	Investment-grade equivalent
2.0-4.0%	450-800 bps	2.0-3.0x	Core BB cat bond range
4.0-6.0%	700-1100 bps	1.8-2.5x	Higher-risk tranches
6.0-10.0%	1000-1600 bps	1.5-2.2x	B-rated equivalent
>10.0%	1400-2500 bps	1.3-2.0x	First loss positions

Illustrative pricing. See pricing disclaimer.

A 400 bps spread on 2% expected loss is a 2.0x multiple. Market pricing typically ranges from 2.0x to 5.0x depending on peril type, modeling confidence, sponsor quality, and market capacity.

Post-loss hard markets (like 2023 following Hurricane Ian) see multiples compress as spreads rise faster than modeled expected losses are revised upward.

Cat bond lite

Private placements using cat bond mechanics but without 144A registration.

Smaller deal sizes ($25M-$100M)
Faster execution
Often shorter tenors
Same risk analysis applies
Less liquidity than registered deals

Cat bond lite structures have grown as sponsors seek more flexible, cost-effective alternatives. The structural protections and trigger mechanics mirror standard cat bonds, but the investor base is typically smaller and trading more limited.

Historical loss experience

Cat bonds were considered nearly loss-free until 2017. Then reality arrived.

Major loss events

Year	Event	Triggered Bonds	Industry Cat Bond Losses
2011	Japan earthquake + tsunami	Muteki Ltd., others	~$300M
2017	Harvey, Irma, Maria	Multiple	~$1.1B
2018	Camp Fire, Michael	Kilimanjaro III Re	~$150M
2022	Hurricane Ian	Several	~$2B+

The 2017 hurricane season was the first major stress test. Multiple bonds with Florida hurricane exposure triggered partial or full losses. Recovery rates varied:

Indemnity triggers: Full principal loss common when reserves developed
Industry index triggers: Partial losses based on PCS index levels
Parametric triggers: Binary outcomes based on measured wind speed/pressure

Cumulative performance (1997-2024)

Total issuance: $200B+
Total losses: ~$4B
Loss rate: ~2% of cumulative issuance
The majority of bonds matured without any loss

Extension provisions

Most indemnity cat bonds include extension provisions that trap principal if an event occurs near maturity.

Standard extension terms

Situation	Extension
Event occurs in final 12 months	6-24 month extension
Reported losses exceed [X]% of limit	Automatic extension
Sponsor discretion	Usually requires cause

Extension risk

If your 3-year bond extends by 24 months post-event, you have trapped principal that:

Cannot be redeployed
May ultimately experience loss
Earns only collateral return (not risk spread)

The risk spread compensates you partly for extension risk. Bonds with longer extension provisions should price wider.

Partial early redemption

Some structures allow partial redemption if reported losses are below a threshold at specific dates:

If reported losses < 25% of limit at 12 months post-event, redeem 50% of principal
Balance remains to cover potential additional development

Reset mechanisms

Multi-year cat bonds may include reset provisions to adjust terms at anniversary.

Attachment reset: Attachment point adjusts annually based on index (inflation, exposure growth). Example: $50B attachment grows 2% annually to $51B in year 2.

Premium reset: Spread adjusts based on market conditions or loss experience, usually within a collar (original spread +/- 50 bps).

Sponsor options: Right to cancel at anniversary (returning principal), increase limit at pre-agreed spread, or adjust perils covered.

Comparison to corporate credit

A BB-rated cat bond with 3% expected loss at 600 bps spread compares to:

Asset Class	Typical Spread
BB corporate bonds	250-350 bps
Leveraged loans	400-500 bps
High-yield bonds	350-450 bps

You’re paid a premium for illiquidity, complexity, and the binary/tail nature of the risk. Unlike credit, where losses develop gradually, a cat bond can go from full principal to zero in a single event.

When cat bonds fit vs. alternatives

Use Case	Cat Bond	ILW	Collateralized Re
Large multi-year capacity	Best fit	Less common	Annual commitment
Quick execution	6-10 weeks	1-2 weeks	2-4 weeks
Custom trigger	Yes	Index only	Yes
Deal size	$75M-$1B+	$10-100M	Varies
Secondary liquidity	Moderate	Limited	Very limited
Regulatory treatment	Securities	Reinsurance	Reinsurance

status: draft

For trigger mechanics that determine when principal is lost, see Trigger types. For modeling considerations, see Catastrophe modeling.