Asset class of financial instruments transferring insurance risk to the capital markets, of which catastrophe bonds are the prime example, enabling institutional investors to access insurance risk returns outside the balance sheet of traditional reinsurers.
Insurance-Linked Securities (ILS) refer to a family of financial instruments whose return and principal repayment are conditioned on whether insurance events, primarily natural catastrophes, occur or not. They represent the financialized form of reinsurance, enabling institutional investors (pension funds, hedge funds, family offices) to access insurance risk directly without going through the balance sheet of a traditional reinsurer. The founding idea is to widen the available capacity by mobilizing global savings to absorb shocks the reinsurance market alone would struggle to bear. The ILS class comprises several sub-categories. Cat bonds are the most liquid and standardized form. Collateralized reinsurance is a private, less liquid form in which the reinsurer places collateral in a trust. Sidecars are temporary co-investment vehicles attached to a reinsurer's balance sheet during hard markets to expand its capacity. Industry loss warranties (ILWs) are binary contracts triggered by the overall market's loss level. The major appeal of ILS lies in the low correlation of catastrophe risk with financial markets, since a hurricane does not depend on stock-market conditions, which makes them a portfolio-diversification tool. In 2024, the ILS market totaled around 115 billion dollars, of which 45 billion were in cat bonds. The market suffers from liquidity constraints following a major catastrophe and from a trapped capital phenomenon, whereby collateral posted as security is only released slowly as claims are settled. Cyber is an emerging and difficult field for ILS, because modeling the risk and defining a clear trigger are markedly more complex than for natural perils.
A Swiss pension fund allocates 2% of its portfolio to a specialist ILS fund, which invests in a basket of cat bonds covering Atlantic windstorm, Japanese earthquake and Australian cyclone risks. Over ten years, the fund shows near-zero correlation with the MSCI World, with a Sharpe ratio of 0.8 but two years of significant losses during the 2017 and 2022 catastrophe seasons.
ILS, titres liés à l'assurance, insurance-linked securities, titres assurantiels, sidecar réassurance, collateralised reinsurance