status: draft

Collateralized reinsurance, ILWs, and sidecars

Beyond cat bonds, ILS investors access insurance risk through three related structures: collateralized reinsurance, industry loss warranties (ILWs), and sidecars. Each serves different investor needs and cedent objectives.

Collateralized reinsurance

Traditional reinsurance forms (quota share, excess of loss) with 100% collateralization. The fastest-growing segment of ILS at $50-60B outstanding.

Why collateralization matters

In traditional reinsurance, you rely on the reinsurer’s credit rating and balance sheet. If the reinsurer fails, the cedent may not collect. Collateralized reinsurance eliminates this counterparty risk by requiring the reinsurer to post 100% of limits upfront.

This opens the market to non-rated capital providers: hedge funds, pension funds, and dedicated ILS funds that lack insurance company ratings but can post collateral.

Quota share structures

Investor takes a proportional share of the cedent’s book:

• 10% quota share = 10% of premiums, 10% of losses
• Includes attritional (non-cat) losses
• Typically written by ILS funds seeking diversified exposure
• Premium flows quarterly or annually
• Losses settled as incurred

Economics example:

• Quota share percentage: 15%
• Cedent premium for covered book: $200M annually
• Your share: $30M premium
• Ceding commission: 30% ($9M back to cedent)
• Net premium to investor: $21M
• Loss ratio on book: 65%
• Your loss share: $19.5M (65% of $30M)
• Net underwriting profit: $1.5M

Quota share returns are lower volatility but also lower expected return than excess of loss structures.

Excess of loss structures

Investor takes a layer above an attachment point:

• $10M xs $20M = pays losses from $20M to $30M
• Only activated by large events
• More “cat bond-like” risk profile
• Binary outcomes on individual events
• Higher expected return, higher volatility

Layer positioning matters:

Layer	Expected Loss	Spread	Attachment Return Period
$50M xs $100M	1.5%	400 bps	1-in-80 years
$50M xs $50M	3.5%	700 bps	1-in-40 years
$50M xs $25M	6.0%	1000 bps	1-in-20 years

Illustrative pricing. See pricing disclaimer.

Lower attachment = higher expected loss = higher spread. Choose based on risk appetite and portfolio construction needs.

Fund structure

Most collateralized reinsurance is written through dedicated ILS funds:

1. Fund receives investor capital
2. Fund writes reinsurance contracts with cedents
3. Posts collateral to trust accounts for each contract
4. Returns principal + premium - losses to investors

Key fund terms:

Term	Typical Range
Management fee	1.0-1.5%
Performance fee	10-20% over hurdle
Lock-up	1-3 years
Redemption frequency	Annual or quarterly
Redemption notice	60-180 days

The illiquid nature of collateralized reinsurance (annual contracts, trapped collateral post-event) requires patient capital.

Industry loss warranties

ILWs trade as contracts rather than securities but serve similar risk transfer functions. $10-15B notional outstanding.

Structure

Feature	ILW
Format	Reinsurance contract or derivative
Trigger	Industry index (PCS for US)
Typical attachment	$20B, $30B, $50B (US hurricane)
Typical limit	$25-100M per contract
Collateral	100% at trade date
Tenor	1 year (annual renewal)

Settlement mechanics

If PCS US hurricane index exceeds the attachment point, the buyer receives payment.

Example:

• Attachment: $50B
• Exhaustion: $60B
• Limit: $100M
• Industry loss: $55B
• Payout calculation: $100M x ($55B - $50B) / ($60B - $50B) = $50M

Linear payout between attachment and exhaustion. Full limit at or above exhaustion.

ILW vs. cat bond comparison

Factor	ILW	Cat Bond
Documentation	Reinsurance contract	144A offering docs
Liquidity	Bilateral negotiation	Secondary trading
Size	$10-100M typical	$100-750M typical
Regulatory treatment	Reinsurance	Securities
Tenor	Annual	3-5 years
Execution time	1-2 weeks	6-10 weeks
Basis risk	Index to cedent losses	Depends on trigger type

When ILWs make sense

For cedents:

• Quick capacity addition for peak season
• Supplement to traditional reinsurance program
• No exposure data disclosure required
• Lower execution costs than cat bonds

For investors:

• Pure industry risk without cedent-specific exposure
• No moral hazard concerns
• Clear, objective trigger
• Annual commitment allows regular reassessment

Index development

PCS continues developing loss estimates for 18-36 months post-event. ILW contracts specify a development period (typically 18-24 months) after which the index reading is final.

Development period considerations:

• Shorter periods = faster settlement but risk of early cut-off
• Longer periods = more accurate but capital trapped longer
• Check historical development patterns for target perils

Sidecars

Quota share vehicles formed to provide capacity to a specific reinsurer. $8-12B outstanding.

Structure

1. Reinsurer forms SPV
2. SPV raises capital from investors
3. SPV writes quota share of reinsurer’s book (or specific segment)
4. Investors participate in premium and losses proportionally
5. Reinsurer earns ceding commission and management fee

Typical terms

Feature	Range
Term	1-3 years
Ceding commission	25-35% of premium
Management fee	5-15 bps
Loss participation	Quota share (first dollar)
Profit share	Often 10-20% to reinsurer above hurdle

When sidecars make sense

For reinsurers:

• Expand capacity without balance sheet growth
• Hard market conditions where third-party capital is available
• Opportunistic capacity for specific renewal seasons
• Reduce volatility of earnings

For investors:

• Access to reinsurer’s underwriting expertise
• Diversified exposure across many cedents
• Aligned interests (reinsurer retains portion)
• Established infrastructure and reporting

Excess of loss sidecars

A variant where the sidecar takes excess of loss rather than quota share:

• Only activated above attachment point
• Higher expected loss, higher return
• More concentrated risk
• More “cat bond-like” profile

Excess of loss sidecars are less common but growing. They offer reinsurers capacity for peak layers without the earnings volatility of keeping that risk on balance sheet.

Retrocession

Reinsurance of reinsurance. Collateralized retro looks like collateralized reinsurance but sits further up the risk chain.

• Higher expected loss than primary reinsurance
• Higher spreads reflect increased tail exposure
• More correlated losses (reinsurers’ retro programs all get hit by same events)
• Often first to face capacity constraints in hard markets

Retro pricing example:

Layer	Market Segment	Typical Spread
Primary excess	Direct cedent	500-800 bps
Retro xs loss	Reinsurer	800-1200 bps
Retro aggregate	Reinsurer	1000-1500 bps

Illustrative pricing. See pricing disclaimer.

Sophisticated ILS investors may allocate to retro for yield enhancement but monitor correlation carefully.

Choosing among structures

Investor Goal	Best Structure
Diversified, moderate return	Collateralized quota share
Higher return, binary risk	Collateralized excess of loss
Pure industry risk, annual	ILW
Access to reinsurer expertise	Sidecar
Multi-year commitment, tradeable	Cat bond
Highest yield, tail exposure	Retrocession

Most ILS portfolios blend structures. Dedicated funds typically allocate 30-50% to collateralized reinsurance, 20-40% to cat bonds, and the remainder to ILWs and opportunistic positions.

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status: draft

For cat bond-specific mechanics, see Catastrophe bonds. For trigger structure details, see Trigger types.