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78 | Mass Transit | MassTransitmag.com | SEPTEMBER/OCTOBER 2014 HE INSURANCE LINKED SECURITIES markets were founded largely to transfer peak catastrophe risks and volatility associated with those risks. ILS products provide an alternative form of risk management protection to traditional non-proportional insurance or reinsurance. Catastrophe bonds are the most common ILS product. A catastrophe bond is a debt security designed to pay losses following a major catastrophe in the event certain negotiated conditions are satisfed as a result of the catastro- phe. Since insurance securitization was pioneered in the mid-1990s, more than $49 billion of property-exposed risk has been transferred to the capital markets in the form of catastrophe bonds. Currently, there is around $18 billion in property catastrophe bonds on risk, the highest level since the market's inception. As of Oct. 31, 2013, 73 percent of all property catastrophe bonds had under- lying exposures to U.S. perils, including hurricane, earthquake, severe thunder- storm, winter storm and brushfre, as measured by contribution of expected loss. The ILS market has been focused on peak property risks, however, new struc- tures continue to be developed and new perils securitized. Since January 2012, an estimated $5 to $6 billion in new capital has entered the market, with around $3 billion fow- ing into the market during 2013. Tese large capital infows have created strong demand from investors for new issuance. In 2013, sponsors began beneftting from this demand, with transactions ofen closing at spreads below the rates expect- ed in the traditional (re)insurance mar- kets. Spreads were down between 30 and 45 percent in the frst half of 2013, com- pared to the fourth quarter of 2012. Tis spurred a very active period of issuance for the frst half of 2013, which contin- ued well into the third quarter. Investors kept pace with the primary activity, even during periods where many transactions were on ofer simultaneously. Motivations for Sponsoring Catastrophe Bonds Catastrophe bonds are typically comple- mentary purchases to a larger risk transfer program, and cedents may consider issu- ing for a number of reasons, including: • Te ability to secure a fxed price over a multi-year period help companies man- age the volatility of pricing cycles • Potentially lower cost of coverage • Accessing a diverse source of capital or securing additional capacity, with traditional reinsurers comprising a rel- atively minor share of the ILS markets • Fully collateralized limits mitigate a ceding company's exposure to capital providers' credit risk for very large in- dustry events • Providing enhanced structured alter- natives to the standard annually renew- able per occurrence cover. Aggregate and subsequent event covers, as well as top- and-drop structures, are regularly issued into the market • Quick payouts may be achieved by uti- lizing certain non-indemnity structures, such as parametric triggers Cat Bond Ma T Before you invest in catastrophe bonds, make sure you understand how the market is going. By Paul Schultz and Erin Lakshmanan Insurance Agreement Issuer: Special Purpose Vehicle (SPV) Ceding Company (Sponsor) Trust Account Counterparty Contract Insurance Premium Counterparty Payment Loss Payment An Overview of