'This is an asset class that should be a permanent part of every investor's portfolio,' says Larry Swedroe
As investors reassess risk in the wake of a devastating hurricane that battered Jamaica, one question is likely resurfacing across institutional portfolios: are catastrophe bonds still worth including in pensions?
For Larry Swedroe, a veteran investing consultant and author, the answer is a hard "yes."
“Of course,” he said when asked if cat bonds are still worth the risk. “The insurance companies aren't idiots. They employ more scientists than probably the US government does to look at the risk of hurricanes. They price for that risk, and then they know sometimes the risk shows up. And when it does, then they react and raise premiums and increase deductibles, tighten underwriting standards. And then over time, when the risks don't show up, there's more demand for the product by investors who would like to chase returns, and the premiums will tend to come down. It’s very simple. This is an asset class that should be a permanent part of every investor's portfolio, whether they're institutional or retail.”
Catastrophe bonds, or “cat bonds,” are designed to pay out when disaster strikes. They shift the financial burden of natural disasters like hurricanes and earthquakes from affected countries to international investors. They’re also among several tools nations can use to secure post-disaster funding. Credit rating agencies view cat bonds as a positive element in a country’s broader disaster risk management strategy.
In the case of Jamaica, the country will receive a full payout of $150 million under its catastrophe insurance coverage with the World Bank. However, even a single event like this - in a relatively small and low-insured region - can stir concerns in broader markets.
While Swedroe doesn’t have hard data on how deeply pension funds are invested in the asset class, he suspects exposure is still relatively limited. Among retail investors, it's even more underrepresented, though that may be changing.
Swedroe believes institutional investors, particularly pension funds, should be increasing their exposure to reinsurance-linked assets rather than shying away. What was once a niche space dominated by hedge funds is now evolving into a broader alternative asset class with growing relevance across investor types, he noted.
“I think it's becoming more of an accepted broader alternative asset that should be considered for everybody's portfolio,” he said.
While catastrophe bonds offer daily liquidity, Swedroe sees greater value in quota shares held in interval funds or private vehicles. These structures, he argued, are better suited for long-term investors who don’t need immediate access to capital, like pension plans.
“You get the illiquidity premium, another one and a half to maybe 2 per cent, and you get better diversification of the risk,” he said, pointing to exposures beyond natural disasters, such as cybersecurity and event cancellation.
He emphasized that catastrophe bonds are just one of several ways investors can access the reinsurance market. He highlighted how quota shares - such as those used by Stone Ridge's SRRIX fund - offer broader and more diversified exposure. Unlike cat bonds, which mostly focus on US hurricane and earthquake risks, quota shares can include events like European windstorms, cybersecurity breaches, and business interruption claims.
Swedroe explained that cat bonds generally sit higher in the risk structure, adding they have large deductibles and only pay out after significant losses.
Cat bonds also come with a unique risk-return profile, which he emphasized investors need to understand. “The most you could earn is the yield or the spread over the T-bills or SOFR rate… and your left tail is your entire investment,” he said, noting that while the premiums may be lower, the exposure is uncorrelated with economic cycles, making it a distinct and strategic asset class.
Swedroe explained that one of the primary reasons investors turn to catastrophe bonds is their complete detachment from traditional market risks. Unlike equities or high-yield bonds, cat bonds aren’t affected by economic downturns, inflation, or interest rate changes, adding that their short-term, floating-rate structure also eliminates duration risk.
This lack of correlation, Swedroe noted, is what makes the asset class so compelling, particularly as a source of portfolio diversification. He pointed out that even in difficult market years, cat bonds often hold up.
“2022 is a great example. Stocks and bonds got killed, whereas cat bonds did fine,” he noted. “To me, it’s an investment as logical as equities, because there is a clear risk premium, just like there is in equity,” he noted.
While returns may be comparable over the long term to high-yield bonds, cat bonds offer a more stable risk profile. With high deductibles in place, losses tend to be rare and limited to years with major events, pointing to 2022’s Hurricane Ian.
Swedroe recalled, “That’s been the only year in the last 20 that the Swiss Cat Bond Index has had a negative return.”
As a result, he sees no logical reason for investors to exit the space after a disaster, especially when such events are expected within the model.
Yet, he stressed how investors often overlook what he calls a natural “self‑healing mechanism” built into the reinsurance market. After a major loss, he explained, insurers rapidly adjust pricing and underwriting to restore capital and reduce future exposure, noting that policies that once carried a $25,000 deductible can jump to $75,000 or even $100,000.
Meanwhile, underwriting standards tighten sharply. For example, in fire‑prone parts of California, homeowners may need cleared brush and wide spacing between trees just to qualify, noting the same happens in hurricane zones, where a house may need concrete construction and windows rated for extreme wind speeds to secure coverage.
He argued that these adjustments reset the risk/return dynamic, which is why abandoning the asset class after a disaster is shortsighted, pointing to the years following 2005.
“The next five of the seven years were double-digit returns,” adding a similar pattern emerged after recent California fires, with premiums rising and returns climbing back into double‑digit territory.
For Swedroe, this cycle is predictable and it’s the reason he thinks “only fools abandon the strategy” after a tough stretch.
Still, he’s optimistic about broader adoption as financial advisors and institutions become more educated on the space. And with more funds ultimately coming to market and increased outreach from experts, including himself, Swedroe said, “You'll see more pension plans than others address it because they're waking up to it.”
