Catastrophe Bond Triggers: How Payouts Are Activated

The trigger is the most important feature of any ILS contract. It is the pre-defined rule that determines whether the investors’ capital is paid to the sponsor.

The trigger must be:

• Binary: The event either happened, or it didn’t.
• Measurable: It must be based on data that is objective and auditable.
• Unambiguous: There should be no dispute over whether the trigger was breached.

Choosing a trigger involves a critical trade-off for the sponsor:

• Minimizing Basis Risk: Basis risk refers to the possibility that the catastrophe bond may not provide a payout when the sponsor experiences an actual financial loss. An indemnity trigger, which is contingent upon the sponsor’s real losses, presents the least basis risk.
• Speed & Simplicity: A parametric trigger, which is determined by a physical event such as wind speed, can be resolved within days, while an indemnity trigger may require months or even years to conclude.

The following pages will explain the main trigger types that are used in the ILS market.