If the Bermuda funds industry was represented in the Twitterverse, the trending hashtag would be #ILSFundStructures.

That translates into Insurance Linked Securities (ILS) fund structures.

If you are engaged in the insurance or funds world, the upswing in the popularity of ILS fund structures will not be surprising to you. But it may surprise some readers to discover that ILS fund structures can have a greater impact on their investments – pensions, or employee incentive schemes, for example -- than they might think.

Broadly, ILS are financial instruments the values of which are driven by insurance loss events, including both natural and non-natural perils.

In Bermuda, to take advantage of the ILS market, the insurance vehicles normally employed are Special Purpose Insurers (SPI), Catastrophe Bonds (Cat Bonds) and "Sidecars".

An SPI is an insurer that writes sophisticated, fully collateralised (i.e. funded) reinsurance business.

Cat Bonds reinsure high-severity but low-probability risks, such as hurricanes, floods or earthquakes. Cat Bonds are usually grouped together and reinsured by other reinsurers, and sold on capital markets thereby spreading the risk among many investors.

Sidecars are specialised reinsurance vehicles formed by reinsurers seeking greater capacity in the reinsurance market. Sidecars usually underwrite specific risks for specified amounts of time.

The funds world is made up of two main types of fund structures: hedge funds (for institutional investors) and mutual funds (usually available to retail investors), however, such a distinction is not made in the Bermuda as all funds are referred to as mutual funds or simply funds.

A fund is an investment vehicle that is made up of a pool of money collected from many investors for the purpose of investing in securities with the goal of generating high returns.

Funds are operated by managers who invest the fund's capital using advanced investment strategies and attempt to produce capital gains and income for investors. A fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Typically, ILS and funds work together when a Bermuda fund invests directly into an ILS vehicle and that vehicle in turn uses the invested capital to reinsure the risks of a third party insurer.

Fund managers like diversity and investing in ILS vehicles gives them the diversity of investment they are looking for. In addition, because ILS vehicles are disconnected from the capital markets, they tend to traverse economic ebbs better than traditional financial markets driven investments.

For instance, if the stock market drops, this will not affect the ILS vehicle. ILS vehicles also reinsure high-severity, low-possibility events (i.e. natural disasters), or the occurrence of a specific event during a specified period of time, also known as "trigger events". If there is no trigger event before the maturity of the reinsurance contract, investors (i.e. the fund) receive their principal investment in addition to any interest earned on the investment during the lifetime of the contract.

In the wake of the economic crisis, ILS fund structures are attractive to pension funds, life insurance companies and employee incentive schemes because they offer the ability to improve a portfolio's investment performance through high-yield investments.

In 2013, 65 per cent of ILS investment in Bermuda came from ILS funds. At the end of May 2014, there were 83 ILS vehicles listed on the Bermuda Stock Exchange having an aggregate value of almost $12.5 billion.

So, the next time you look at your pension statement or your general investment portfolio and see that you indirectly own shares in 'XYZ Re Ltd.', you will know that your investment manager has included ILS fund structures as part of your investment strategy.

Article first published in The Royal Gazette, June 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.