Catastrophe Bond

A coupon that stops if the hurricane arrives

A catastrophe bond transfers the risk of a natural disaster from an insurer to capital markets. Investors buy notes, the money sits in a collateral account earning a money market return, and they are paid a spread on top. If a defined event occurs, the principal is written down and paid to the sponsor instead. It is a reinsurance contract in the shape of a bond, and its return has almost nothing to do with the economy.

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What the lesson covers

1. What it is
2. Triggers
3. The layer
4. Why it’s used
5. Risks to watch

Key terms

• Sponsor — The insurer or corporate transferring the risk, and the party the bond pays when an event occurs.
• Collateral account — Where the note proceeds are held, so the vehicle can always pay and the investor takes no credit risk.
• Parametric trigger — A payout condition based on physical measurements alone, settling quickly and matching losses imperfectly.
• Attachment point — The loss level at which the bond begins to lose principal.
• Exhaustion point — The loss level at which the bond’s principal is entirely gone.
• Multiple — The spread divided by the modelled expected loss — the market’s standard relative value measure.

In practice

Pension funds and specialist funds are the main investors, usually as a diversifying allocation rather than a core one. Sponsors are insurers, reinsurers and occasionally public bodies covering earthquake or storm exposure. The same structure has been extended to other rare, measurable events, and the design questions are always the same three: what triggers it, where does it attach, and who modelled the loss.

Read next

• Weather Swap — A payout driven by temperature, not price
• Credit-Linked Note — A bond whose repayment depends on a credit event
• Longevity Swap — Insuring against people living longer than planned

In the app, Catastrophe Bond carries a five-step lesson, a worked example and a bank of twelve questions drawn differently every sitting.

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Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.