Catastrophe Risk

Catastrophe reinsurance is simply insurance for insurance companies and provides protection against natural catastrophes. Reinsuring catastrophe risk can help insurance companies manage earnings volatility and reduce the amount of capital needed to support their exposures. The amount of notional exposure that trades in the catastrophe reinsurance market each year is approximately $220B.

There are various segments of the reinsurance market and Nephila almost exclusively focuses on property catastrophe risks exposed on a worldwide basis to natural perils such as earthquake, hurricane and winter storm. This risk is transacted on reinsurance documentation and predominantly falls into the following four categories: 1) Catastrophe Bonds (cat bonds), 2) Industry Loss Warranties (ILW), 3) Indexed Products, (CWIL, ZWIL, INCR, etc), and 4) Direct reinsurance. We are also participants in the Retrocession market.

Catastrophe Bonds

Cat bonds are 144A securities which provide reinsurance protection to the issuing company (usually an insurance or reinsurance company) in the case of a catastrophic event. They are often structured as floating rate notes whose principal is lost if specified trigger conditions are met. Cat bonds are structured to offer issuers the benefit of fully-collateralized reinsurance, which significantly mitigates the credit risk an issuer would normally accept from rated counterparties in the reinsurance market. The most common trigger types for cat bonds are: indemnity, industry or parametric index and modeled loss. Total issuance of cat bonds (excluding mortality and life settlement bonds) typically averages around $4B per annum.

Industry Loss Warranties (ILW)

An ILW is a type of reinsurance contract or option where the payout is triggered when a catastrophic event causes losses to the entire insurance industry in excess of a predetermined trigger amount. The industry insurance losses are calculated and reported by a third party index provider such as Property Claims Services (PCS) in the United States and PERILS outside the United States. For example, assume two counterparties agree to an option trade where the option settles in-the-money if a single US hurricane causes losses to the insurance industry of $50B+ (binary/digital option). For this protection, the option buyer agrees to pay an option premium of 10%. If a US hurricane then occurs and causes a total industry insured loss greater than $50B, the seller of an ILW option would lose the full notional amount of the contract, less the option premium paid by the buyer. Various ILW options trade in the market, such as call spreads and knock-out options, and the strike price and region/peril combinations are completely customized to fit the seller or buyers appetite. The annual volume of ILWs traded in the reinsurance market is approximately $5B.

Indexed Products (CWIL, ZWIL, INCR, etc)

An innovative form of catastrophe reinsurance cover transacted on a private basis. Similar to an ILW in that losses trigger off of a PCS trigger, but exposures are then disaggregated at the county level, to match the insurance counterparty's specific exposures. This has the effect of significantly reducing the counterparty's basis risk when compared to buying standard ILW cover, while for investors the potential for long claims development periods is reduced. The annual volume of private transactions traded in the reinsurance market is approximately $20B.

Direct Reinsurance

Direct reinsurance is the most traditional form of risk transfer in the market, where an insurance company buys catastrophe protection from a reinsurance company. Coverage in the direct reinsurance market is provided on an indemnity basis, unlike ILWs which are trigger off an index of industry claims. Direct reinsurance is generally transacted using a reinsurance contract and this market is by far the largest method of risk transfer for catastrophe exposures at an estimated $200B notional transacted annually. The vast majority of participants in the direct reinsurance market are rated insurance and reinsurance companies, although specific collateralized layers are becoming more common.


Retrocession cover ("Retro") refers to the insurance a reinsurance company would buy from another reinsurer to protect themselves against catastrophic events. Traditional retro is similar to direct reinsurance in that the coverage is provided on an indemnity basis. Retro is typically the most volatile market in terms of price movement and availability of capacity. The annual notional traded in the retro market is estimated to be around $5B.