Alternative Capital: ILS, Cat Bonds, and Sidecars

Insurance-Linked Securities

Insurance-linked securities (ILS) bring capital market investors into the reinsurance market. Catastrophe bonds are the most well-known form: an insurer or reinsurer sponsors a bond that pays investors an above-market coupon. If a defined catastrophe occurs (measured by industry loss, parametric trigger, or modeled loss), investors lose some or all of their principal, which is used to pay claims. Cat bonds have grown to over $40 billion outstanding, providing diversification for investors because catastrophe risk is largely uncorrelated with financial market risk.

Sidecars and Collateralized Reinsurance

Sidecars are special purpose vehicles that allow investors to participate in a reinsurer's book of business for a defined period. The reinsurer manages underwriting, and investors share proportionally in premiums and losses. Collateralized reinsurance provides fully collateralized coverage, eliminating counterparty credit risk. These structures have made reinsurance capital more elastic, expanding during profitable periods and contracting after losses. Actuaries in the ILS space model catastrophe risk, structure transactions, and develop triggers that align investor and sponsor interests while minimizing basis risk.