Indemnity trigger
The trigger of an insurance-linked security based on the losses actually paid by the sponsor, as opposed to an index or objective parameter.
In January 2024 Beazley placed PoleStar Re, a $140 million cyber catastrophe bond on an indemnity trigger and the first cyber deal of its kind sold under Rule 144A. The choice of trigger surprised no one. An indemnity bond pays on the sponsor's actual losses. The other triggers look elsewhere: an industry index trigger at a published market loss, a parametric trigger at a measured physical value, a modeled loss trigger at the output of a model run on the event. The cedent carries no basis risk because it recovers what it lost. The cost falls on the investor. The sponsor keeps control of the underwriting, reserving and claims decisions that determine the amount due, which creates moral hazard. The market contains it with a retention, a calculation agent and loss reviews, and the spread pays for the rest. There is also the delay. An indemnity payout waits for claims to develop, and an extension period can keep collateral tied up well past the scheduled maturity. Moving to an index would remove both problems at the cost of basis risk, and cyber still lacks a seasoned industry loss index, largely because the market has not agreed on what counts as an event.
Textbook case: an insurer issues a cyber catastrophe bond with an indemnity trigger. Investors cannot see its portfolio and depend on its claims handling. They accept the risk only because the sponsor has an established reputation, and the spread they demand prices that moral hazard.
indemnity trigger, UNL trigger, ultimate net loss trigger
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