The creation of crop futures, then forward metal markets, and later financial market futures enabled risk to be transferred from those who naturally have the risk as part of their regular commercial activities to speculators and traders. The insurance industry was running short of capacity for insuring certain sorts of risk after the impact of Hurricane Andrew in 1992, and turned to pass risk on to the capital markets in the form of insurance-linked bonds. The creation of new securities, the return of which is tied to insurable events, allowed different sources of capital to share in the risk of the insurance industry (see Box 1).

The introduction of new securities is a fertile time to make money as there are always neophytes unknowingly taking on risk at a price they shouldn’t. In newly traded markets the advantage lies with those who have expertise in the "underlying”. In the case of insurance-linked securities it was not just the insurance companies who necessarily started off with such an advantage so much as re-insurance companies, a sector dominated by a few, large companies.

So it is important that companies that now invest and trade in insurance-related securities, a growing area of alternative investing, truly understand the primary insurance and re-insurance markets. Credit Suisse's Insurance Linked Strategies Group (ILS Group) is headed by Niklaus Hilti who was Head Actuary at Helvetica Reinsurance, as well as formerly being Head of Catastrophe Pricing Converium Ltd in Zurich, and a Pricing Actuary at Zurich Re.

Two catalytic years for insurance-linked securities
The earliest sort of insurance-linked securities were related to reinsurance of large-scale risk. These Super Catastrophe Bonds are widely known as Cat Bonds. Issuance of cat bonds grew slowly – only $8 billion worth were issued in the period up to 2002. In the time since, two periods became significant to how the market for insurance-linked securities developed. First, 2005 became a notorious year for large insurance losses because of hurricanes Katrina, Wilma and Rita landing on the continental United States. These losses compelled an accelerated issuance of insurance-related securities, and by the end of 2007 the liquid cat bond market jumped in size to about $14 billion in bonds outstanding. A good six billion of those bonds covered US hurricane risk alone.