As the insurance-linked securities (ILS) market continues to expand, the diversification of risk portfolios has never been more crucial, and according to François Divet, Head of ILS at AXA Investment Managers (AXA IM), the expanding range of perils within the ILS space could help.In an article, Divet highlighted how 2024 was a remarkable year for the ILS sector, as the market witnessed record growth, with issuance up 10.5% year-on-year, reaching $17.2 billion.Now nearing $50 billion in outstanding assets, the market has come a long way from its origins, which were largely focused on traditional natural catastrophes such as hurricanes, earthquakes, and floods.However, as the world faces evolving risks, such as cyber threats, terrorism, and even longevity risks tied to life insurance, the ILS market has expanded to offer coverage for these new and emerging dangers.

But, whilst this diversification into non-traditional perils such as cyber-attacks and terrorism is a positive development, Divet highlights a critical point: “Adding new perils to ILS portfolios could enhance its diversification – a key factor in most portfolios, but it does not necessarily improve the diversification for the end investor, as new perils are at risk of higher correlation to markets and more complex/less accurate modelling.” The addition of new perils like cyber and terrorism risks can undoubtedly offer greater variety to ILS portfolios.Focusing on cyber ILS, the market saw its first cat bond issued in 2023, and since then, the market has seen 10 cyber-ILS issuances totalling over $800m.As a reminder, about every cyber cat bond transaction, including the first private cat bond deals and the more recent 144A cyber cat bonds,  Concurrently, terrorism bonds, which began with the UK’s Pool Re in 2019, are now expanding into international markets, as seen in the first terrorism cat bond issued in France in late 2024 by GAREAT, the French terrorism risk insurance pool.

“One thing these two types of perils have in common – and which they don’t share with traditional nature-related cat bonds – is that they are man-made,” Divet notes.“Because of this there are ways for insurers to mitigate these risks,” he added.“In the case of cyber-attacks, insurers can audit and suggest improvements to the policyholder’s computing infrastructure.

In the case of terrorism, Pool Re offers a variety of programmes and tools aimed at incentivising good security and risk management behaviours,” Divet continued.However, while these new perils are appealing for their diversification potential, Divet highlights how they present new challenges for risk modelling.“Unlike natural catastrophe risks, where modelling frameworks have been refined over decades and where for example seasonal and geographical patterns impact the risk assessment, cyber risk is less understood and keeps evolving,” Divet further explained..

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