Yield compression won’t halt growing investor appetite for cat bonds: Morningstar DBRS

While catastrophe bond yields have declined from the highs seen between 2022 and 2024, analysts at Morningstar DBRS expect demand for the asset class to remain strong. Saying that, despite recent yield compression, the market continues to offer equity-like returns that are largely uncorrelated to traditional stock and bond markets.

In a recently published report, Morningstar DBRS emphasises how forecasts from the National Oceanic and Atmospheric Administration (NOAA) for this year’s Atlantic hurricane season act as a short-term sentiment and pricing catalyst.

The agency notes that these forecasts can pressure near-term yields, particularly for bonds exposed to hurricane risk, but supply-demand factors remain more dominant in general.

“Seasonal predictions like the NOAA’s hurricane forecast act as a short-term sentiment and pricing catalyst in the CAT bond market, typically affecting yields in the near term, particularly for bonds exposed to hurricanes. However, their impact is temporary and secondary to the deeper forces of long-term risk modeling, capital supply, and market demand, which ultimately drive the asset class,” analysts explained.

Adding: “Despite their short-term influence, NOAA forecasts do not fundamentally change CAT bond valuation models as CAT bonds are priced using multidecade catastrophe models rather than one-year forecasts.

“These models incorporate long-term frequency and severity distributions, climate-adjusted risk assumptions, and exposure growth. The key implication is that a single below-normal forecast does not materially reduce the expected loss over a CAT bond’s term.”

As we’ve been reporting on Artemis, the catastrophe bond market has gained traction amongst a number of government entities for a number of years now, particularly in regions that are prone to material severe storms and seismic activity.

In May, we reported that the government of Portugal is considering catastrophe bonds as a potential mechanism that could be utilised to provide risk capital for disaster resilience and to better manage catastrophe risk exposure within the country.

Within its Portugal Transformation, Recovery and Resilience Plan (PTRR), the government outlined a significant EUR 22.6 billion spending plan to boost economic resilience and encourage durable development.

However, this momentum isn’t limited to Europe. Looking across the Atlantic, Morningstar DBRS also believes a similar framework could apply to North American risk management.

Turning attention towards Canada, Morningstar DBRS said: “With this precedent and the strong investor demand, the question arises as to whether Canada, which is currently in the process of developing its own federal government-backed insurance backstop, could adopt an approach similar to those of some other countries in issuing CAT bonds as part of a government backed earthquake risk management program that provides coverage beyond what is covered by insurers and reinsurers.”

All in all, Morningstar DBRS’ analysts expect investor appetite within the cat bond market to continue to expand.

“CAT bonds are widely considered an attractive, high-performing alternative asset class. We expect investor demand for CAT bonds to continue to grow, especially because they have low correlation with returns on traditional financial assets, as CAT bond returns depend on whether a specified natural catastrophe occurs.

“For issuers, CAT bonds offer a unique opportunity to reduce their catastrophe risk exposure without entering a reinsurance contract that must be renewed yearly, thereby enhancing predictability.”

Concluding: “CAT bonds remain an increasingly important risk transfer tool despite near-term fluctuations driven by seasonal forecasts such as NOAA’s 2026 outlook. While a below-normal hurricane season may compress spreads and moderate yields in the short term, it will not materially alter the underlying credit risk profile of the asset class, which is anchored in long-term catastrophe modeling and structural protections such as full collateralization.”

Comparably, even after recent declines in pricing of new catastrophe bond issuance, the asset class still stacks up well against other true diversifiers. But we imagine there will come a time, if reinsurance market softening persists, where investor appetites may slow for making new or additional allocations, so market dynamics over the coming months (as well as loss activity) will prove key for how their appetites evolve over the next year.

You can analyse catastrophe bond market yields in this chart.