Insurance Linked Securities: the basics


Insurance-linked securities (“ILS”) are innovative financial vehicles that are increasingly used to finance peak, non-recurrent insurance risks, such as hurricanes, pandemics and earthquakes, and other types of losses. ILS are significant because they are offered directly to capital markets, reducing cyclicality and expanding risk bearing capacity in the reinsurance market. The distinguishing characteristic of ILS is the ability to isolate pure insurance risk from credit risk and other types of market risk and transform this risk into a capital markets form. Consequently, ILS are one of the few truly non-correlated assets that investors can purchase. In addition, the yield on ILS has historically been higher than similarly rated securities and liquidity in secondary markets is improving. ILS volume has grown substantially in the last three years and ILS now present a competitive substitute for reinsurance in many non-life markets.

This article broadly explains ILS: the most common forms; the reasons why (re)insurers and investors are attracted to ILS; shortcomings of ILS; how ILS are legally structured; and, how each element of the structure works together.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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