DEFINITION of 'Catastrophe Swap'

A customizable financial instrument traded in the over-the-counter derivatives market that enables insurers to guard against massive potential losses resulting from a major natural disaster. In a catastrophe swap, two parties, an insurer and an investor, exchange streams of periodic payments. The insurer's payments are based on a portfolio of the investor's securities, and the investor's payments are based on potential catastrophe losses as predicted by a catastrophe loss index.

BREAKING DOWN 'Catastrophe Swap'

In the wake of a large natural disaster, numerous policyholders will file claims within a short time frame, placing significant financial pressure on insurance companies. A catastrophe swap helps insurance companies transfer some of the risk they've assumed through policy issuance and provides an alternative to purchasing reinsurance or issuing a catastrophe bond.

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