Collateral

The investor’s principal (capital) that is put up at the start of an ILS transaction.

Collateral in catastrophe bonds and insurance-linked securities arrangements is held in a secure trust account and is used to pay the sponsor if the trigger event occurs. It makes the protection 100% “fully funded” or “fully-collateralized”.

Collateral can be in various forms, ranging from cash, to instruments such as letters of credit, or the market value of investments (often US Treasuries linked), and its primary purpose is to ensure there are funds available to pay claims after an insured event.

A key concept in insurance-linked securities is trapped collateral, which occurs when collateral is frozen after a loss event because the final amount of claims remains uncertain. This can result in capital being unavailable for reinvestment until the loss is fully quantified, as it remains held in the ILS structure to ensure any claims that do arise can be paid.