Money For the Rest of Us – Episode 549

Why Catastrophe Bonds Yield 12%. Should You Invest?
Date: January 28, 2026
Host: J. David Stein

Episode Overview

In this episode, J. David Stein explores the world of catastrophe bonds ("cat bonds"): what they are, why yields are currently as high as 12%, and if individual investors should consider them. Stein dives into how climate change has affected insurance and reinsurance markets, details the unique risk profile of cat bonds, and evaluates the newly launched ETF that allows retail access to this traditionally institutional asset class.

Key Discussion Points & Insights

1. Climate Change & the Insurance Industry (00:35–07:30)

• Stein recounts recent travel to Florida, noting extreme rainfall and referencing NOAA data showing significant increases in storm intensity, not just in hurricanes but unique, severe rain events.
• Quotes the 2026 AON Climate and Catastrophe Insight report:
  "Extreme weather events are becoming more frequent and unpredictable. It's affecting new geographies and sectors." (03:20)
• Insurance companies face increasing economic and insured losses from non-peak perils (e.g., severe convective storms rather than just earthquakes or major hurricanes).
• Economic losses from natural disasters in the prior year totaled $260 billion, with the US experiencing the most significant insured losses due to non-peak perils.

2. How Reinsurance Works & The Role of Float (07:30–10:10)

• Stein explains reinsurance (insurance for insurers), referencing Warren Buffett’s 2002 Berkshire Hathaway annual letter:
  "Cheap reinsurance is a fool's bargain. When an insurer lays out money today in exchange for a reinsurer's promise to pay a decade or two later, it's dangerous and possibly life-threatening..." (09:38)
• The concept of "float": insurers get premiums upfront, invest them, and hope underwriting profits exceed payouts.

3. Catastrophe Bonds: What Are They? (10:10–12:40)

• Traditional reinsurance is increasingly supplemented or replaced by catastrophe bonds—insurance-linked securities sold to investors who take on disaster risk in exchange for high yields.
• Cat bonds typically have three to five-year maturities and are structured as private, institutional investments (Rule 144A securities), though this is changing with new ETFs.

4. Why Cat Bonds Yield So Much (12:40–17:10)

• Cat bond yields are high—currently in the 8–16% range, with new ETFs offering around 12%—because investors are absorbing natural disaster risk, not credit or interest rate risk.
• Historical performance (Swiss Re Global CAT Bond Index):
  • 20+ years: 7.6% annualized returns (vs. 3.6% for US Aggregate Bond Index; 7.3% for high yield)
  • Only one negative year (-2% in 2022)
• Cat bonds offer diversification—returns rely on weather events, not corporate defaults or rate moves.
• Memorable moment:
  "What's intriguing about cat bond investing is you're not exposed to default risk... This is a different return driver. If there is a severe natural disaster, then the insurance company can collect from the cat bond issuer." (13:35)

5. Structure & Triggers of Cat Bonds (17:10–20:20)

• Cat bonds protect against specific perils (e.g., hurricanes, earthquakes) in defined regions and usually cover the most extreme loss layers.
• Payouts are triggered either by actual insurer losses (indemnity) or by industry-wide losses (industry trigger).
• Investors’ principal is held in a trust (usually T-bills or similar), with returns coming from both interest and insurance premiums.
• Long-term, average losses (i.e., investor principal lost to disaster payouts) drag returns from gross yields (~12%) to net outcomes (~7%).

6. Access for Individual Investors & The New ETF (20:20–23:30)

• Historically, cat bonds were for institutions. Example: Stoneridge High Yield Reinsurance Fund required $250,000 minimum.
• New accessibility:
  • Brookmont Catastrophe Bond ETF (Ticker: ILS), launched April 2025
    • Yielding 11.5%+ (coupon)
    • 71 bonds, mostly windstorm exposure (esp. Florida, Louisiana), some diversification (e.g., California earthquake, Japan)
    • B+ average credit rating equivalent, but risk is not credit—it’s catastrophe
    • $39 million AUM, 1.58% expense ratio
    • Since inception: 5.9% return (less than a year)
    • Liquidity note: about 13% held in T-bills (for ETF liquidity)
• Notable quote:
  "Now we have a public, daily-traded wrapper around an illiquid investment." (23:05)
• Considerations:
  • High yields are before disaster losses; after payouts, returns could fall to 7% or even lower.
  • Key concern: Is the risk appropriately priced? Fund manager selection is critical as investors rely on their catastrophe modeling.
  • Possibility for timing exposure (e.g., lightening up before hurricane season), but generally best approached as a "hold and observe" asset.

7. Risks and Long-term Outlook (23:30–25:30)

• Cat bonds are exposed to rising natural disaster frequency and severity, especially from climate change.
• The key question: Can future returns match historical 7%? Or will increasing storms erode returns?
• Stein summarizes the appeal and uncertainty:
  "I find it really intriguing because it's a different return driver. But…I recognize that due to climate change, natural disaster risk is increasing, especially flood risk, wind risk, and storm risk. But they don't happen every year." (24:35)
• Final food for thought:
  "Is this something you're going to invest in? We'll see." (25:31)

Notable Quotes

• On underwriting discipline:
  "In order for their insurance operations to generate this low-cost float over time, they have to...underwrite with unwavering discipline, price the insurance correctly, reserve conservatively, and avoid the compounding of risk." (09:05)
  (attributing Warren Buffett)
• On diversification:
  "You're not exposed to default risk of corporations...you're exposed to natural disaster risk. This is a different return driver." (13:35)
• On investor access:
  "Now we have a public, daily-traded wrapper around an illiquid investment." (23:05)
• On the future of returns:
  "Hopefully we can earn a 7% annualized return that this type of investment has achieved historically." (25:00)

Key Timestamps

| Timestamp | Segment | |---------------|-----------------------------------------------------------| | 00:35 | Florida storms, climate risk acceleration | | 03:20 | AON & Financial Times – disaster cost trends | | 07:43 | Warren Buffett on reinsurance and float | | 10:10 | How catastrophe bonds divert risk to investors | | 13:35 | Unique risk profile of cat bonds | | 17:10 | Cat bond structure and triggers explained | | 21:00 | Brookmont Catastrophe Bond ETF details | | 23:05 | ETF liquidity and practical investor concerns | | 24:35 | Reflections on risk and the climate future | | 25:31 | Final thought on investability |

Tone & Takeaway

Stein’s tone is measured, informative, and inquisitive. He expresses genuine curiosity about the growing cat bond market and remains cautious about the risks. He highlights the novelty of direct retail access via ETFs but reminds listeners that the appeal of high yields is counterweighted by unpredictable, climate-driven risks.

For listeners:
This episode offers a thorough primer on cat bonds and their rise in today’s climate-impacted financial landscape. It’s particularly valuable for investors seeking non-traditional diversifiers beyond credit or rate-sensitive assets—while underscoring due diligence and risk awareness as extreme weather becomes ever more costly.