Sustainability Language

Sustainable Finance & Investment

Catastrophe bond

A high-yield bond that transfers disaster risk from insurers to capital markets — investors lose principal if a defined catastrophe occurs.

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Definition

An insurance-linked security through which a sponsor (insurer, reinsurer, government or agency) transfers specified catastrophe risk — hurricanes, earthquakes, floods — to capital-market investors. Investors receive enhanced coupons; if a triggering event occurs during the risk period (typically about three years), principal is diverted to pay the sponsor's claims, partially or fully.

References

Munich Re

ILS definition; cat bonds transferring catastrophe risk to capital markets; investor principal funding claims.

Overview

What it means

Cat bonds convert insurance risk into a tradeable asset class attractive for its low correlation with financial markets. Structures park investor principal in safe collateral while paying floating-rate coupons; triggers vary in basis risk: indemnity (sponsor's actual losses), industry-loss indices, parametric (event metrics like wind speed or earthquake magnitude), and modelled-loss.

The market has grown from hurricane risk into pandemic, wildfire and cyber, and is increasingly used for sovereign and development-finance resilience — the World Bank and Mexico's FONDEN have issued cat bonds, and the structure now features in climate-adaptation finance discussions as pre-arranged disaster funding.

How it is used

Reinsurers (Munich Re, Swiss Re) structure and place ILS; institutional investors (dedicated ILS funds, pension funds) hold them for diversification; governments use them for disaster risk financing alongside contingency funds and parametric insurance.

Why it matters

Cat bonds are the flagship of risk transfer for a climate-disrupted world — putting capital-market capacity behind disaster resilience, and testing how societies pre-finance escalating extreme-weather losses.

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