Trapped collateral
The portion of collateral an investor cannot recover at maturity because losses remain uncertain.
Irma, September 2017, then Jebi in Japan, September 2018: on both, loss estimates kept rising for months, and at the January 2019 renewal part of the ILS funds' capital was still held back on contracts whose cover period had ended. That is trapped collateral. At expiry, the cedant points to losses incurred but not settled, and the contract lets it keep, on its own estimate, enough to pay them, sometimes for several years. A traditional reinsurer does not face the problem: it reserves and keeps writing on the same balance sheet. The collateralized investor has locked a precise amount for a precise period, and whatever is held back cannot be redeployed at the next renewal, just when prices are rising because of the very losses that trap it. Wordings have tightened since: release thresholds, mandatory review dates, an independent expert to arbitrate the amount withheld. Trapped collateral is still the main reason ILS capacity contracts after a heavy season.
After a heavy hurricane season, a fund finds in early 2026 that 31 percent of its collateral, that is 218 million dollars, remains trapped on 2024 and 2025 contracts whose losses are unsettled. January renewal prices rose 22 percent. The opportunity cost on the capital it cannot redeploy is put at 14 million dollars for that year alone.
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