Catastrophe bond market can return ~8.5% in 2025 with expected losses: Lane Financial
The catastrophe bond market is forecast to have the potential to deliver a total return of around 8.5% in 2025, even after accounting for an expected level of losses to bonds during the year, according to consultancy Lane Financial LLC.
Pricing in the catastrophe bond market is said to be “slouching just south of neutral,” according to the latest report from Lane Financial.
This means, cat bond pricing, for the outstanding stock of 144A natural catastrophe insurance-linked securities (ILS), sits just below neutral as of the first-quarter of 2025, but still some way above what the consultancy would consider a true soft market.
Lane Financial had called the hard market in cat bond pricing as having ended back in April 2024, then reporting that cat bond pricing remained in neutral territory as of October last year.
Now, it is just south of neutral, as the average spreads on offer with catastrophe bonds fell towards the end of 2024, recovering somewhat in early 2025.
Lane Financial explains, “Following the two fat years of 2023 and 2024, ILS investors may well ask what can be expected in 2025. The fat years gave total returns in the high teens followed by low teen returns, as measured by annual percentages for the ILS Nat Cat market. Our total return estimate for 2025, based on current pricing for the whole ILS portfolio, would be around 8.5%. This assumes a) a steady Federal Reserve policy leaving Treasury rates perhaps one notch lower than at present, and b) an underwriting year with loss performance close to expectations.”
A lot can happen that could derail the forecast around 8.5% return for natural catastrophe bonds in 2025, from catastrophe losses to Federal Reserve decisions that reduce the risk-free rate.
But, the consultancy further explains, “For 2025 present pricing shows a weighted average yield of 6.61% and a current expected loss of 2.26% – thus an expected underwriting yield of 4.35% (=6.61% – 2.26%). Add to that the floating rate. Presently the Fed is at 4.25%-4.5% , and one notch lower would put it at 4%-4.25%. Splitting the middle of that range and adding the underwriting expectation rounds to a rate of 8.5%.”
Which is a reasonable way to think about the return-potential of the catastrophe bond market at any point in time.
Looking at the catastrophe bond market yield data set (from Plenum Investments), as of the end of February 2025 the implied return of the cat bond market after accounting for an expected level of catastrophe losses, by subtracting the expected loss, is slightly lower at 8.18%.
In its latest cat bond pricing analysis, Lane Financial also looks at how multiples-at-market have changed over time, saying that many academic papers have suggested that the cat bond market has experienced a relatively steep drop in multiples since its earlier days, with a novelty premium is often cited as the reason.
However, Lane Financial’s analysis finds that while there has been a decline in multiples, it is nowhere as steep as suggested if you analyse the market on a constant expected loss basis.
Stating that, “It is hard to conclude that the range of pricing has changed very much in the last 25 years. If there was a novelty premium, it was small and has certainly now disappeared.”
The new paper is not yet available on the Lane Financial website, but reach out and ask if you would like a copy.
