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A strategy that\u2019s delivered specialist investors\u00a0huge returns<\/a>\u00a0is now facing scrutiny, amid concerns that its risk-reward dynamics might be skewed against some issuers.<\/p>\n Catastrophe bonds, which are issued by insurers, reinsurers and governments seeking an extra layer of disaster coverage, have been handing investors double-digit returns. Issuers, meanwhile, have seen their costs soar.<\/p>\n Grievances surfaced in July, after it emerged that Jamaica\u2019s catastrophe bond wasn\u2019t triggered by the devastation wrought by hurricane Beryl. Though the entire Caribbean island was officially declared a\u00a0disaster area<\/a>, the carefully calibrated terms of the bond meant its holders were shielded from losses. In the event, it was decided that the precise level of\u00a0air pressure<\/a>\u00a0required for a payout wasn\u2019t achieved.<\/p>\n For cat bond investors \u2014 who are currently reaping an average return of around 15% after raking in 20% in 2023 \u2014 the outcome in Jamaica underpins the appeal of a strategy that\u2019s attracted some of the brightest minds in finance. For others, it\u2019s set off a difficult debate.<\/p>\n Caribbean heads of government within the group known as\u00a0Caricom<\/a>\u00a0recently discussed the financial ramifications of Beryl. This month, the group said it will be seeking \u201can examination\u201d of cat bonds and other insurance-linked securities, and wants the region\u2019s finance ministers to take a closer look at which markets governments should choose and which they should avoid.<\/p>\n \u201cWe recognize that at the end of the day, investors need to make returns,\u201d Jwala Rambarran, a former governor of the central bank of Trinidad and Tobago, said in an interview. \u201cBut at the same time, fairness and equity says it can\u2019t be all the time that the investors are making the returns. It\u2019s a one-way street.\u201d<\/p>\n The Jamaican Ministry of Finance didn\u2019t respond to requests for comment.\u00a0<\/p>\n The country\u2019s $150 million cat bond \u2014 arranged by the World Bank and bought by private investors \u2014 was issued this year to replace a 2021 bond. The new bond costs the government 60% more per unit of coverage, which reflects the heightened risk posed by climate change as well as higher reinsurance costs, according to\u00a0Conor Meenan<\/a>, a risk finance specialist at the London-based\u00a0Centre for Disaster Protection<\/a>.\u00a0<\/p>\n Cat bonds make it possible for issuers (also referred to as sponsors) to pass part of their risk over to capital markets. Sales of the instruments have soared lately, with factors including climate change, population density and inflation adding to their appeal. Investors face potentially substantial losses if a bond is triggered, but can generate market-beating returns if a predefined catastrophe doesn\u2019t occur.\u00a0<\/p>\n For the $47 billion cat bond market, Beryl proved an early win for investors navigating their way through a hurricane season that\u2019s expected to be unusually active.\u00a0<\/p>\n Zurich-based Plenum Investments AG, one of the private-market buyers of Jamaica\u2019s cat bond, said it was drawn to the opportunity to diversify away from the US market. \u201cWe also like the\u00a0parametric<\/a>trigger structure, which minimizes uncertainty post event,\u201d Plenum said in an emailed response to questions.\u00a0<\/p>\n Issuers turning to cat bonds get a very specific type of coverage whose terms should be clear to all stakeholders at the point of purchase, according to the World Bank.\u00a0<\/p>\n Cat bonds are \u201cfor tail events,\u201d which are rare disasters outside the norm, said\u00a0Michael Bennett<\/a>, head of derivatives and structured finance at the World Bank treasury. \u201cThe parameter isn\u2019t the fine print, it is the print.\u201d\u00a0<\/p>\n In the case of Jamaica, Beryl very narrowly missed hitting the parameter that would have caused the bond to pay out. The pressure reading \u201cwas one or two millibars too high in one or two zones,\u201d said Robert Muir-Wood, chief research officer in insurance solutions at Moody\u2019s. \u201cIt was a very close call.\u201d<\/p>\n Rambarran, the former Trinidad and Tobago central banker, recently co-authored a report by the\u00a0Vulnerable Twenty Group<\/a>\u00a0\u2014 or V20 \u2014 which represents countries who are among the world\u2019s most exposed to climate change. V20 says it\u2019s time to overhaul the triggers that determine whether a cat bond investor will be called on to cover losses. The group\u2019s concern is that thanks to skillful financial engineering, such triggers are becoming increasingly narrow and rigid.\u00a0<\/p>\n In the case of Jamaica\u2019s cat bond, investors were protected because the conditions for triggering a payout \u201care hard and specific,\u201d the V20 report said. \u201cThis rigidity protects investors but leaves Jamaica vulnerable to catastrophic risk.\u201d<\/p>\n Sara Jane Ahmed, managing director and finance adviser to the V20 group and the report\u2019s lead author, says it\u2019s \u201cclear that we need a lot more financial protection triggers that are reliable and timely.\u201d<\/p>\n The \u201cdisappointing\u201d payout outcome of Jamaica\u2019s cat bond underscores the need for the World Bank \u201cto reassess the usefulness of this complex and costly financial instrument and even perhaps for Jamaica to renegotiate the terms of its cat bond,\u201d the report concluded.<\/p>\n But designing cat bonds with lower trigger thresholds would only drive up the price, according to the World Bank.\u00a0<\/p>\n \u201cIf you want these bonds to pay out more frequently, you\u2019ll be charged more in premiums,\u201d said\u00a0George Richardson<\/a>, director of capital markets and investments at the World Bank treasury. \u201cThere\u2019s a trade-off to be considered.\u201d\u00a0<\/p>\n Aside from Jamaica, investors were spared losses on cat bonds in Mexico and Texas, which were also hit by Beryl. Other forms of disaster insurance did pay out, however. The Caribbean Catastrophe Risk Insurance Facility, or CCRIF, disbursed a\u00a0record<\/a>\u00a0$44 million to Grenada due to Beryl\u2019s destruction. CCRIF also delivered smaller payouts to other Caribbean nations, including Jamaica.<\/p>\n And with a total disaster safety net of $1.6 billion, Jamaica is particularly well-insured against the threat of hurricanes, according to Meenan. \u201cThey\u2019re taking risk very seriously,\u201d he said.<\/p>\n The Philippines chose not to renew its cat bond when it lapsed in 2022, favoring an\u00a0indemnity insurance program<\/a>. Bennett at the World Bank, which helped arrange the country\u2019s catastrophe risk insurance, says the government in Manila is still \u201cconsidering cat bonds as part of their larger insurance strategy.\u201d\u00a0<\/p>\n Ahmed of the V20 group says that \u201cas development partners think about their role in this climate crisis, part of that is really taking a hard look at some of these products.\u201d And then \u201cfiguring how do we make them fair,\u201d she said.<\/p>\n<\/div>\n\nRecommended Newsletter: <\/strong>CEO Daily provides key context for the news leaders need to know from across the world of business. Every weekday morning, more than 125,000 readers trust CEO Daily for insights about\u2013and from inside\u2013the C-suite. Subscribe Now<\/a>.<\/div>\n