Investing in catastrophes

Hurricane Melissa has grown into a massive Category 5 storm barreling straight for Jamaica, where it made landfall today in what’s expected to be the worst storm to ever hit the island nation.

It’s obviously a horrible disaster for the country and its citizens, but the hurricane’s arrival also brings with it bad news for investors holding a very specific sort of investment: catastrophe bonds.

Catastrophe bonds are securities in which investors provide insurers with the money they need to pay claims from natural disasters like hurricanes, earthquakes, and more. Effectively, they transfer the risk of enormous insurance payouts from the insurer to investors: The idea is that if a disaster arrives that’s so massive that insurance companies can’t pay out all their claims, capital markets can provide the liquidity needed to cover the rest.

Hurricane Melissa’s arrival in Jamaica will likely trigger the country’s $150 million catastrophe bond, organized last May by the World Bank. But while that money will go to helping the country recover from this disaster, it will likely be a drop in the bucket: Experts forecast total damages will cost somewhere between $5 billion and $16 billion, according to Bloomberg.

A disastrous investment

Catastrophe bonds are high-risk, high-reward investments. Investors receive sizable yields for buying the bonds: Jamaica’s bond pays out a yield of about 7%, compared to a 10-year Treasury yield of just under 4% today.

But in exchange, if a natural disaster strikes before the bond matures, investors lose everything. That may sound like a gamble, but since catastrophe bonds first appeared on the market in the 1990s, they’ve been growing more popular. The Financial Times reported in July that insurers had already sold $18.1 billion in catastrophe bonds this year, compared to $17.7 billion across all of 2024.

While the rewards currently outweigh the risks, that math may soon change for one simple reason: Climate-related disasters are arriving with increasing regularity.

“The average annual cost of natural catastrophes from 2017 to 2024 has cost insurers $146 billion,” according to Gallagher Re’s 2024 Natural Catastrophe and Climate Report. But last year, public and private entities paid out $154 billion around the world for natural disasters. Fewer hurricanes than forecast means that this year may be better for bond holders, but disasters still abound: The California wildfires alone will cost the US $40 billion.

Only time will tell if these investments remain profitable, or if they turn into a market catastrophe.—MR