Insurance-Linked Securities (ILS)
Insurance-linked securities are securitized risk transfer instruments that transfer insurance risk – particularly natural catastrophe risk – directly to capital market investors, bypassing the traditional reinsurance market.
Concept
Insurance-linked securities (ILS) are financial instruments whose repayment or coupon is linked to the occurrence of a defined insurance event (e.g., a natural catastrophe of a certain intensity). They allow insurers and reinsurers to transfer risk directly to capital market investors, thereby accessing alternative capacity outside the traditional (re)insurance market.
Catastrophe Bonds as the Primary Form
The best-known form of ILS is the catastrophe bond (cat bond), under which investors, in exchange for an attractive coupon, accept the risk of a total loss of their invested capital should the trigger event defined in the bond occur. Other forms include sidecars, industry loss warranties (ILW), and collateralized reinsurance.
Relevance for the Reinsurance Market
ILS capital has become a firm complement to traditional reinsurance capacity, particularly for peak natural catastrophe risks; the availability of ILS capital has a dampening effect on the price swings of the classic hard market/soft market cycle, since institutional investors, unlike traditional reinsurers, generally view insurance risk primarily as uncorrelated diversification within a broader investment portfolio.