Every answer and its explanation appears here once you have finished the path. Each one then links to the matching glossary entry, where the concept is set out in full with its worked example.
1. In a cat bond, where is the money that will pay the sponsor if the trigger is met?
In a locked collateral account, funded at issue by the proceeds subscribed by investors
The capital is placed as collateral at issue, usually in highly liquid securities, in a vehicle legally separate from the sponsor. That prior funding is what gives the instrument its value: nothing depends on a capital call or on a counterparty's future health at the moment the whole market would be under strain.
Glossary entry · catastrophe-bond2. What does a cat bond settle that traditional reinsurance does not?
Counterparty risk: the money is already locked, where an ordinary cover is a promise to pay whose value depends on the carrier's future strength
That is exactly the contribution, and it matters most for an event of very high severity, that is, when the whole market calls at once. A cat bond does not remove basis risk, it creates some as soon as the trigger stops being indemnity based, and its set-up costs rule out small programs rather than making it cheaper.
Glossary entry · ils3. Among the four trigger families of an insurance-linked instrument, which one opens no gap with the sponsor's actual loss?
The indemnity trigger, which follows the actual loss, at the price of a settlement that waits for the run-off
Only the indemnity trigger follows the sponsor's loss, so only it opens no gap. It has a cost worth naming: settlement waits for the run-off, and the investor must trust someone else's claims handling. The other three pay faster and diverge from the actual loss the further they move from the sponsor's own loss.
Glossary entry · declencheur-parametrique4. A cedant places a 40 million euro layer with a collateralized fund. What does that collateral NOT guarantee?
That the contract wording covers what one thinks, nor that payment exceeds the posted amount by one euro
Collateral settles credit risk and only that. It does not read the contract on the cedant's behalf: an exclusion, a loss definition or a cap remain what they are. And a trust account never pays beyond what it holds, where a traditional reinsurer can in practice go a little further to preserve a commercial relationship.
Glossary entry · reassurance-collateralisee5. What did the Vesttoo collapse of 2023 reveal about collateralized reinsurance?
That collateral does not guarantee its own existence: over one billion dollars of letters of credit supposedly issued by banks were forged, and the banks had no record of them
The internal investigation of July 2023, followed by a United States bankruptcy filing in January 2024, concerned the authenticity of the documents and not the ability to pay nor any model. What gave way is the link nobody audited in depth because it looked like an administrative formality. Posting in advance remains the best known answer to counterparty risk; what failed is the idea that posting excuses you from verifying.
Glossary entry · effondrement-vesttoo6. On what basis do a sidecar's investors participate in the sponsor's portfolio?
On a quota share basis: the same fraction of premiums and the same fraction of every loss
A sidecar is a financialized quota share, and everything true of a quota share is true of it: sponsor and investor interests are aligned in the strict sense, and the investor cannot win on a portfolio where the sponsor loses. That is what radically separates it from a cat bond, where the investor carries a peak the sponsor is protected from.
Glossary entry · sidecar-reassurance7. Why is a sidecar's temporary nature presented as its main attraction?
Because it absorbs a peak of demand without growing a permanent balance sheet that could not be deflated the following year
The comparison with an equity raise makes the point: equity raised in a hard market still has to be remunerated when the market softens, and it is not handed back without a heavy transaction. A two-year sidecar unwinds at its term. What is bought is therefore not cheaper capital, it is reversible capital, and the question is how long the hardening lasts.
Glossary entry · traite-quote-part8. A sponsor wants protection against a major event on its catastrophe portfolio. Between a sidecar and a cat bond, what should it be told?
That a cat bond removes a peak tranche while a sidecar shares everything proportionally: only the first answers a need for severity protection
A sidecar being a quota share, it divides good and bad results by the same number and removes no peak: it brings capacity to write more, which is useful but different. Confusing the two means buying volume while believing you are buying protection, and the sponsor finds out on the very major event that was meant to be covered.
Glossary entry · risque-concentration9. What triggers payment under an industry loss warranty?
The whole market's insured loss, measured by an index, crossing an agreed threshold, regardless of the buyer's own loss
That is what makes the instrument disconcerting: it breaks with the principle governing all insurance by not looking at the loss of the party buying it. Its most widespread form is binary, the threshold is crossed and the whole amount is due, or it is not and nothing is. No notification, no survey, no run-off period: settlement follows publication of the index estimate.
Glossary entry · garantie-perte-sectorielle-ilw10. Why do some industry loss warranties condition payment on the buyer having a loss of its own?
Largely for classification reasons: a contract transferring no insurance risk is not treated as reinsurance
A purely index-based instrument resembles a wager on an event whose consequences the buyer need not suffer, and that resemblance has accounting and regulatory consequences depending on the jurisdiction. The own-loss condition brings the deal closer to ordinary reinsurance and changes its classification as much as its economics. It slows settlement rather than speeding it up.
Glossary entry · trigger-parametrique-indemnite11. Which of the two directions of basis risk poses the structural problem, and why?
The negative one, because you receive less than your loss or nothing at all, and you find out during the loss, whereas the positive one announces itself
Nobody forgets to bank a payment above their loss, which makes the positive gap visible and discussable at leisure, notably on how much risk was really transferred. The negative gap only shows up when the money was being counted on. Nothing guarantees the two offset either: they depend on the portfolio's geography, not on chance.
Glossary entry · risque-de-base12. Of the three causes that widen basis risk, which one is genuinely corrected by the choice of trigger?
Geography, by tightening the area measured or aggregated onto the one where the portfolio is concentrated
Geography is the most frequent cause and the only one worked by comparing two maps, therefore the only one the choice of trigger really moves. Vulnerability depends on the portfolio and not on the instrument, and revision of the estimate depends on the index provider. Believing the trigger settles basis risk means treating one cause out of three.
Glossary entry · cresta-zones13. What is taken from the experience of Hurricane Irma in 2017 on Caribbean parametric cat bonds?
That several did trigger on the wind parameters measured, and that sponsors nevertheless found a noticeable gap between their actual losses and the compensation received
The instruments worked as written, and that is precisely what makes the episode instructive: the gap came from unusual tracks and geographic disparities in the sponsors' exposure, not from a failure to perform. It fed a lasting debate on trigger design, which was not abandoned, and it made plain that the gap is observed after the fact while it is decided at drafting.
Glossary entry · reassurance-catastrophe14. What is retrocession, as against cession?
The floor above: a reinsurer passes on part of the risks it has accepted to another reinsurer
The chain then continues, a retrocessionaire being able to retrocede in turn, and it is that cascade that spreads very large risks across the world market. Transferring a portfolio of losses already incurred describes something else, a retrospective transaction, which is not a floor of the prospective transfer chain.
Glossary entry · cession-retrocession15. What is the defect of retrocession practiced in a closed circle, among a small group of participants?
It does not spread the risk, it circulates it: it comes back to strike its original carrier and accumulates at the nodes of the circle
Each believes it has transferred part of its exposure when it has kept it by an indirect route. The London market lived through this at the turn of the 1990s: carriers who believed themselves protected found the same loss several times in their accounts, each turn of the spiral consuming a further layer. What had been bought as protection had become a multiplier.
Glossary entry · spirale-retrocession16. What prudential consequence follows from a risk retroceded in a closed circle?
The risk has not left but been recycled, so it should not ease the requirement as a real cession to a third party outside the circle would
A group counting as transferred an exposure that returns to it by another route would believe itself stronger than it is, and would believe it before the event, that is, when that error costs most. It is also why the useful check is event-based and not contractual: the list of treaties never shows that accumulation, each contract being regular taken on its own.
Glossary entry · diversification17. An extreme mortality bond protects a life insurer against something its own book does not absorb. Against what exactly?
Against a common cause shock, which moves the whole book the same way at the same time
A life insurer pools deaths that are independent of one another, and that is its entire trade: the law of large numbers does its work there. It stops doing so the moment the cause becomes common, whether pandemic, major catastrophe or extreme event, because the whole book then moves together. That residue, and only that, is what the instrument goes to the capital markets for. The third option describes longevity risk, which is the opposite exposure; the fourth describes counterparty risk, which locked collateral does address but which is not the instrument's reason for being.
Glossary entry · obligation-mortalite18. Longevity risk is one of the largest exposures in the world, between fifteen and twenty-five trillion dollars, and yet it resists securitization where a mortality shock lends itself to it. Why?
Because it is a slow trend, never resolved, and its market is one sided since no investor gains from someone else's survival
The reason is not one of size and it is not technical, it lies in the shape of the risk. A mortality shock is dated and bounded, so it fits inside a three year contract at the end of which the investor knows what it gained or lost. Longevity is a drift that never resolves, and its most dangerous part, the one coming from medical progress, is also the least amenable to modeling. To that is added the market's asymmetry: nobody holds a natural opposite interest to hedge, so there is no economic counterparty on the other side. That is why its home remains the reinsurer's balance sheet, where it partly offsets against mortality.
Glossary entry · risque-longevite19. A loss portfolio transfer and an adverse development cover are both retrospective reinsurance. What separates them?
The first transfers the portfolio and its reserves; the second leaves it in place and covers only the overrun beyond an attachment
The first is an exit, the second is tail protection, and confusing them is expensive because they have neither the same balance sheet effect, nor the same counterparty profile, nor the same price. The loss portfolio transfer moves the claims and their reserves out in economic terms, and the reinsurer takes on the whole run-off. The adverse development cover moves nothing: it leaves the cedant carrying its reserves and responds only beyond the agreed attachment. The third option describes the line between prospective and retrospective reinsurance, which runs elsewhere: both instruments bear on losses that have already occurred.
Glossary entry · transfert-portefeuille-sinistres20. A cedant enters into a retrospective reinsurance transaction on old liability years. What is the specific weakness of the counterparty risk it has just taken on?
It is correlated with the peril transferred: the acquirer fails precisely when the liabilities develop badly
The transaction exchanges a claims risk, known and capable of being reserved, for a counterparty risk, and the exchange would only be a good one if the second were independent of the first. It is not. An acquirer specialized in legacy has taken on portfolios of the same nature from several cedants, so all its acquisitions deteriorate together if the common factor materializes: a court decision widening a liability, claims inflation, a serial peril emerging. The protection weakens at the exact moment it must respond, as in a retrocession spiral. The first option is wrong for another reason that matters as much: the transaction never extinguishes the cedant's obligation toward its policyholders.
Glossary entry · reassurance-retrospective21. A group opens a captive carrying the first twenty million euros of its annual losses, and announces a 30% saving on its external premium. What should be concluded from that?
That the premium has fallen, but the group must now hold in capital and administer what it no longer pays: the comparison only means something net of that cost
It is not a saving, it is a shift. The group no longer pays premium on the first twenty million because it carries them itself, so it must hold in own funds what it no longer pays, tie that capital up outside its industrial uses, and run a company under full prudential regulation, with its governance, its reporting and its actuarial function. The comparison may well stay favorable once corrected, and often does, but it is then no longer 30%. The fourth option is wrong for a distinct reason: the captive itself buys market cover above its retention, so the group remains a buyer for the part of the risk that could actually hurt it.
Glossary entry · captive-reassurance22. In a fronting arrangement, the fronting insurer has ceded the whole risk to the insured group's captive. On what does its own safety then rest?
On the security it takes against it, deposits, pledges or letters of credit, and on verifying that security at source
The fronting insurer remains legally liable toward the insured and must pay the claim even if the captive to which it ceded the risk fails: the first option describes exactly what fronting does not do. Its safety therefore rests not on the contract but on the security taken against it, and on confirming that security with the institution supposed to have issued it. That precise link is what a documented incident laid bare: in the Vesttoo affair, forged letters of credit were discovered in July 2023 and the company filed for bankruptcy in January 2024. The fourth option contradicts itself, since the captive's lack of a local license is the very reason the fronting insurer exists.
Glossary entry · fronting23. After Hurricane Maria, in September 2017, Dominica received a 19.3 million dollar parametric payout from CCRIF in under two weeks, against damage estimated at 1.3 billion. How should that ratio be read?
As emergency cash: derisory as an indemnity, it funded the first operations without waiting for assessments or international aid
The instrument is not sized to rebuild, it is sized to pay for the first weeks, at the very moment a state's receipts fall and its spending jumps. The mismatch it buys is one of timing, not of scale. Nor is this a basis risk case, since the threshold did match an event actually suffered, and a parametric payout is never topped up after adjustment: that is precisely what is given up in exchange for speed.
Glossary entry · ccrif24. In 2016, the African Risk Capacity's model at first triggered no payout for Malawi despite an observed drought, and roughly eight million dollars was paid after recalibration. Why is this case the reference for sovereign basis risk?
Because it shows a modeled index can stay below its threshold while the damage is real, leaving a government to explain a premium paid for nothing
Basis risk takes a political form for a state: the gap between index and damage has to be explained to a population, on the day that population has the least patience. ARC had made its first payouts in January 2015 to Senegal, Mauritania and Niger, which shows the arrangement works; the Malawi case shows that the calibration of the index, not the principle, decides how faithful the cover is, and that it is settled at drafting.
Glossary entry · african-risk-capacity-arc