Insurance Linked Securities (ILS) are financial instruments whose fundamental value is determined by insurance losses, caused by natural catastrophes such as major earthquakes and hurricanes. As the returns of ILS are primarily driven by natural catastrophes, when carefully structured, they are generally uncorrelated with the overall financial market, which can make ILS an attractive asset class for capital market investors.
Cat Bonds are privately offered insurance linked securities that transfer a specified set of risks from a sponsor to investors, Cat Bonds are generally not publicly traded, trading solely in over the counter markets. They emerged from a need by insurance companies to alleviate some of the risk they would face if a major catastrophe event occurred. In short, they are insurance for insurance and reinsurance companies, and are provided by issuing bonds on to investors. Most Cat Bonds are structured to offer insurers the benefit of fully collateralized reinsurance, which significantly mitigates the credit risk an issuer would normally accept from rated counterparties in the reinsurance market. They are generally categorized into 4 basic trigger types.