ILS provides an opportunity for the insurance sector to transfer some types of risk to the capital markets. They are primarily used whenever the insured risks are too huge or less predictable to be covered by a standard insurance package, such as hurricanes, earthquakes, or many other catastrophic events.
The most commonly used type of ILS is a catastrophe bond. Catastrophe bonds are issued by an insurer or a special purpose vehicle and coupon payments are received at periodic intervals. At a predefined catastrophic event, the principal of portion or all the bond is siphoned off to recover losses leaving the investors with capital loss. However, if such event is not to happen during the life span of a bond then at maturity investors will get back their principal. Except for that, ILS falls under the sidecars, industry loss warranties (ILWs), and mortality bonds.
ILS instruments are still more skewed toward large-scale events, but their characteristics may also make it suitable for personal risk coverage.