Insurance Linked strategies (ILS) provide investors with access to reinsurance-related catastrophe risk, offering returns profiles that are generally uncorrelated with traditional asset classes. Like a reinsurer, investors assume indirectly a defined portion of insurance risk, typically linked to events such as hurricanes, earthquakes, or other natural and man-made disasters, in exchange for a contractual risk premium. While this can provide steady returns if the predefined event does not occur, investors may experience potential losses if a covered event happens during the investment period, reflecting the loss-sharing nature of the underlying risk transfer.
The ILS asset class emerged in response to systemic shocks from Hurricane Andrew in Florida (1992) and the Northridge earthquake in California (1994), both of which resulted in insured losses far exceeding expectations and led to widespread strain – and in some cases insolvency. These events underscored the limitations of balance-sheet based risk capacity of the traditional (re-)insurance market and catalyzed the development of alternative risk transfer mechanisms like ILS.
Capital markets responded by stepping in as supplemental risk carriers, offering (re-)insurers a means to transfer peak risks – such as those arising from severe natural catastrophes – to a broader investor base. By transferring part of their peak risks to the capital markets, (re)insurers could better manage large-scale disasters, while investors gained access to attractive risk adjusted return profiles that are uncorrelated to traditional financial markets.
Historical performance of Cat Bonds vs. other asset classes
The ILS market predominantly covers property catastrophe risks in developed insurance markets, particularly in regions with significant insured exposures vulnerable to natural perils. The predominant risk covered is U.S. windstorm, most notably in Florida, followed by U.S. earthquakes, Japan typhoons and earthquakes, Europe windstorms, and wind and earthquakes in Australia and New Zealand.
While the ILS sector initially focused on natural disasters, the market has gradually expanded to cover selected man-made risks like aviation, marine, energy, and cyber risk, though these still represent a relatively small portion of the overall market.
ILS transactions can vary. Structures may cover a single peril (e.g., US wind), a combination of named perils (e.g., US wind and US earthquake), or broader multi-peril coverage across defined geographies – ranging from specific states, countries, regions, or global portfolios. Triggers can be indemnity-based, parametric or modeled loss, depending on the cedant preference and investor appetite.
In addition, Life and health insurance related risks, covering risks such as longevity and excess mortality and pandemic events, but also man-made risk such as cyber risk are also becoming a larger part of the ILS market. These instruments offer valuable diversification benefits as they tend to be uncorrelated with both natural catastrophe and traditional market risks.
The insurance risks can be transferred by insurers and reinsurers to the capital market through various instruments. The two principal structures are Cat Bonds (short for “Catastrophe Bonds”) and Collateralized Reinsurance.
Cat Bonds are standardized, tradable securities that typically have maturities of up to five years. The bonds are fully collateralized with collateral held in a segregated trust account and generally invested in high quality, short-duration assets such as money market instruments. Returns consist of the collateral yield plus a risk premium (or “coupon”) tied to the specific underlying catastrophe risk. Cat Bonds offer some secondary market liquidity facilitated by dedicated OTC brokers. Liquidity can decline and spreads may widen during or following major catastrophe events. The global Cat Bond market is currently valued at around $50 billion, with around 75% of issuance linked to U.S. windstorm risk.
Collateralized Reinsurance, also known as "Private Transactions," are bespoke contracts. They offer broader diversification and greater customization compared to Cat Bonds. With an estimated market potential of approximately $400 billion - estimated based on the natural catastrophe capital in the reinsurance sector - this market is significantly larger than that of Cat Bonds. Contracts are typically structured with a 12-month risk period, aligned with the traditional reinsurance renewal cycle, and there is no secondary market for these instruments. Like Cat Bonds, they are fully collateralized, with collateral held in a segregated trust account and generally invested in high quality, short-duration assets such as money market instruments, providing a floating return in addition to the risk premium.
These transactions are typically facilitated through regulated reinsurers or special purpose insurers (also called “risk transformers”). These structures enable ILS funds to access reinsurance contracts and capture returns from both the collateral and the contractual risk premium.
Data as of June 2025. Source: Euler, Aon.
The ILS market offers a range of investment strategies and approaches, each with distinct risk-return characteristics, liquidity profiles and underlying exposures:
- Concentrated vs. diversified strategies: may focus on specific risks (e.g., US wind) or spread across multiple geographic zones and perils.
- Natural catastrophe-only vs. mixed strategies: may focus on natural catastrophe risks or include man-made and/or life insurance risks.
- Specific instruments-only vs. broader strategies: may focus on specific ILS instruments such as Cat Bond only, Collateralized Reinsurance or Retrocessional covers, or invest in a blend of structures to optimize liquidity, duration, and risk exposure.
- Long-term vs. opportunistic strategies: Some target long-term insurance risk premia, while others are opportunistic in nature Focusing on post-event dislocations or short-duration trades linked to seasonable renewals.
Comparing these approaches can be challenging due to the inherent complexity of the ILS asset class, limited availability of standardized public data, and the varying levels of disclosure and transparency among ILS managers.