Catastrophe (cat) bonds are a form of insurance-linked securities (ILS), also known as insurance securitization, where insurers transfer risk, usually from a catastrophe or natural disaster through a sponsor, typically a reinsurer, to investors. Insurers and reinsurers typically issue cat bonds through a special purpose vehicle, a company set up specifically for this purpose. Cat bonds pay high interest rates and diversify an investor's portfolio because natural disasters occur randomly, and are not correlated with other economic risk. Depending on how a cat bond is structured, if losses reach the threshold specified in the bond offering, the investor may lose all or part of the principal or interest.
Other forms of insurance-linked securities are based on life, longevity and mortality, and are generally used to raise risk capital for life insurers as well as spread risk, according to Artemis. These securities allow investors to diversify their asset portfolios and provide a process for investors to share in the returns of the life insurance business.