status: draft

ILS diligence guide

A systematic approach to evaluating cat bonds and other ILS investments. Use this as a checklist to ensure you’ve covered the key risk factors before committing capital.

Modeling diligence

Independent model verification

Don’t rely solely on sponsor-provided modeling.

Action	Purpose
Request raw exposure data	Run through your own model license
Request multi-model output	Compare AIR vs. RMS results
Run sensitivity analysis	Understand parameter impacts
Verify model version	Confirm current, not outdated

Model version verification checklist

Item	Check
Vendor and product	AIR Touchstone, RMS RiskLink, etc.
Version number	Current version?
View name	Long-term, near-term conditioned?
Event catalog vintage	How recent?
Run date	When was analysis performed?

Exposure data quality

For indemnity triggers, exposure data drives everything.

Element	Verification
Completeness	Are all policies included?
Geocoding	What % resolved to lat/long vs. ZIP centroid?
Construction type	Coded correctly?
Year built	Available and accurate?
Coverage amounts	Current replacement cost?
Occupancy	Residential vs. commercial correct?
Update frequency	How often is data refreshed?

Sensitivity analysis requirements

Request or run these sensitivities:

Variable	Test	Rationale
Attachment point	+/- $5B	Layer stability
Demand surge	On/off, +/- 10-20%	Major driver for large events
Secondary perils	Include/exclude	Often undermodeled
Model uncertainty	10th/50th/90th percentile	Range of outcomes
Climate view	Long-term vs. near-term	Climate impact

Structural diligence

Trigger definition review

Read the trigger definition word by word. Ambiguity typically favors the sponsor.

Question	Implication
What constitutes a “qualifying event”?	May exclude some events
How is loss measured?	Paid, reserved, ultimate?
Who makes the determination?	Sponsor, third party, arbitration?
What data sources are used?	Official records? Which ones?
What happens if data is unavailable?	Backup procedures

Development period assessment

For index triggers, is the development period sufficient?

Period	Assessment
< 18 months	Short, may truncate developing losses
18 months	Standard, generally adequate
24 months	Conservative, lower basis risk
36 months	For long-tail events, rare

Check historical PCS development patterns for your target perils. Major hurricanes may still be developing at 18 months.

Extension provisions

Provision	Check
Extension trigger	When can principal be trapped?
Maximum extension	How long can extension last?
Release conditions	What triggers release?
Compensation	Does risk spread continue?
Partial release	Any early release provisions?

Extensions beyond 24 months for index triggers or 36 months for indemnity are off-market.

Collateral investment guidelines

Investment Type	Risk Level
Treasury money market	Minimal
T-bills/notes	Minimal
AAA money market	Low counterparty
Total return swap	Swap counterparty
Corporate bonds	Elevated
Bank deposits	Bank credit risk

If permitted investments include anything beyond Treasuries and AAA money market, understand the incremental risk. You didn’t sign up for counterparty risk.

Financial stability

Factor	Assessment
AM Best rating	A or better preferred
Rating trend	Stable, positive, negative?
Capital adequacy	Well-capitalized?
Recent results	Profitable, stable?
Reinsurance program	Adequate, not excessive?

Underwriting track record

Metric	What to Look For
Historical loss ratios	Vs. modeled expectations
Reserve development	Adverse or favorable?
Geographic concentration	Matches cat bond exposure?
Growth trajectory	Rapid growth = potential adverse selection
Line of business focus	Aligned with cat bond coverage?

Claims handling (for indemnity triggers)

Factor	Assessment
Claims staffing	Adequate for surge events?
Historical disputes	Any contentious claims history?
Reserve adequacy	Track record of accurate reserves?
Reporting timeliness	History of prompt loss reports?
Third-party audits	Available for indemnity triggers?

Track record with previous ILS

Question	Implication
Repeat issuer?	Established track record
Previous triggers?	How were they handled?
Disputes?	Any contested payouts?
Investor relationships	Standing with ILS investors

Legal documentation review

Key documents

Document	Focus Areas
Offering memorandum	Risk factors, trigger definition, extension provisions
Indenture	Payment waterfall, trustee duties, events of default
Reinsurance agreement	Coverage terms, premium payment, loss settlement
Trust agreement	Collateral investment guidelines, release conditions
Swap agreement (if any)	Counterparty terms, breakage provisions

Critical provisions

Provision	Check
Qualifying event definition	Precise, unambiguous
Loss measurement	Clear methodology
Development period	Sufficient length
Extension triggers	Limited, defined
Amendment rights	Investor protection
Dispute resolution	Clear process
Governing law	NY or Bermuda typical

Red flags in documentation

Vague reserve estimation provisions
Limited or no audit rights
Sponsor discretion in loss determination
One-sided amendment provisions
Short development periods
Weak collateral guidelines

Pricing diligence

Spread multiple analysis

Expected Loss	Acceptable Multiple
< 1%	3.0-5.0x
1-2%	2.5-4.0x
2-4%	2.0-3.0x
4-6%	1.8-2.5x
> 6%	1.5-2.2x

If spread / expected loss is below these ranges, you’re not being adequately compensated for the risk.

Comparables analysis

Comparison	Source
Similar peril/attachment	Recent primary issuance
Same sponsor’s prior deals	Track record
Similar trigger type	Structural comparables
Similar expected loss	Risk-adjusted comparables

Pricing red flags

Red Flag	Concern
Multiple below 2.0x	Insufficient risk premium
Off-market attachment	Why different?
Unusually short/long tenor	Execution cost or lock-in risk
Missing model disclosure	Something to hide
First-time sponsor at tight spread	Should pay new issuer premium

Red flags checklist

Modeling red flags

Flag	Why It Matters
Single model reliance	Exposed to model bias
Outdated model version	May miss recent updates
Limited sensitivity disclosure	Hiding something
No independent verification option	Take sponsor’s word
Excessive sponsor “adjustments”	Manipulated output

Structural red flags

Flag	Why It Matters
Ambiguous trigger	Disputes likely
Short development period	Premature cut-off
Weak collateral guidelines	Counterparty risk
Excessive extension	Trapped capital
One-sided amendments	No investor protection

Flag	Why It Matters
Deteriorating ratings	Underwriting problems
History of disputes	Expect more
Rapid exposure growth	Adverse selection
Geographic concentration	Correlated losses
Limited track record	Unknown quality

Rating agency treatment

S&P expected loss mapping

Expected Loss (Annual)	S&P Rating
< 1.0%	BB+
1.0-2.0%	BB
2.0-4.0%	BB-
4.0-7.0%	B+
7.0-10.0%	B
> 10.0%	B- or unrated

S&P may add 10-25% to modeled expected loss for model uncertainty.

Rating agency considerations

Factor	Impact
Model uncertainty	Additional haircut
Basis risk (non-indemnity)	Additional haircut
Extension risk	Considered in recovery
Sponsor credit	Minimal (collateral protects)
Structural complexity	May affect rating

Typical market distribution

Rating	% of Market
BB+	5%
BB	35%
BB-	35%
B+	15%
B/B-	5%
Unrated	5%

Most cat bonds cluster in BB range. Higher ratings (BBB+) are rare because spread premium for low EL doesn’t justify execution costs.

Pre-trade checklist

Before committing capital, confirm:

Category	Verification
Model	Multi-model output reviewed, current version confirmed
Sensitivity	Key sensitivities run and understood
Trigger	Definition read and understood
Extension	Provisions acceptable
Collateral	Guidelines appropriate
Sponsor	Financial stability confirmed
Legal	Key documents reviewed
Pricing	Multiple acceptable vs. comparables
Liquidity	Position size appropriate for secondary market
Portfolio fit	Correlation with existing positions assessed

Post-investment monitoring

Ongoing monitoring requirements

Frequency	Activity
Continuous	Event watch for triggering perils
Quarterly	Sponsor financial reports (if available)
Annual	Model updates, exposure data refresh
As needed	Event loss reports (indemnity triggers)
Maturity	Commutation process (if triggered)

Event response protocol

Event occurs in covered peril/geography
Assess preliminary industry loss estimates
Compare to attachment/exhaustion points
Review sponsor’s initial loss estimate (indemnity)
Adjust marks based on probability of loss
Monitor development through commutation