The use of the insurance-linked securities by primary insurers has surged in 2012.

According to a report released in July by Swiss Re Ltd., the first half of the year was the most active first half for the issuance of these securities since 2007, with about $3.6 billion of catastrophe bonds, issued in 16 transactions and 28 tranches, entering the market.

“The penetration of capital markets-based capacity, whether it be in catastrophe bond form or collateralized reinsurance form, has grown dramatically,” said Cory Anger, New York-based managing director at GC Securities, a unit of Guy Carpenter & Co. “We see a much larger swath of insurers and reinsurers using the products.”

While the insurance-linked securities market remains relatively small compared with traditional reinsurance capacity, it serves a valuable function for insurers, said Judith Klugman, New York-based managing director and head of distributing these securities at Swiss Re Capital Markets Corp.

“You've always had a core of issuers that felt it made sense to complement their overall risk-transfer program by adding catastrophe bonds into the mix, but as the cost of getting that protection through the capital markets has continued to decrease the last six months, we have seen more and more issuers flock to the market,” Ms. Klugman said. “It's not meant to cannibalize reinsurance, but it is made to work on a complementary basis.”

For Tallahassee, Fla.-based Citizens Property Insurance Corp., diversifying its reinsurance programs was a top operational priority, said Sharon Binnun, chief financial officer of the state-run property insurer of last resort.

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“In 2011, Citizens' board decided we needed to transfer risk, and risk transfer to the private sector was the way to do it,” she said. “We also wanted to diversify our reinsurance program, so we budgeted for both traditional reinsurance and catastrophe bonds in 2012.”

Accordingly, Citizens on May 1 announced the signing of a two-year, $750 million cat bond deal issued through its Bermuda-incorporated special purpose insurer, Everglades Re Ltd. The deal, the largest single-tranche cat bond ever, provides several benefits for Citizens, Ms. Binnun said. “One benefit to a cat bond compared to traditional reinsurance is that it is going to be a multiyear transaction, so you are locking in rates,” she said. “Another is that it is fully collateralized so that you don't have credit risk.”

Moreover, the competitive nature of the offering helped save Citizens money, Ms. Binnun said, reckoning the competition among investors to invest in the bond saved the insurer $15 million. Moreover, the knowledge that the state-run insurer now had more options when it came to risk transfer, gave it more leverage when negotiating for reinsurance, saving it an additional $20 million. “We saved some money by bringing competition,” she said.

Ms. Anger said the size of deal augured well for the insurance-linked securities market. “Transactions above $500 million are still rare,” she said. “However, given how heavy the usage of catastrophe bonds was in the first half of the year, the fact that Citizens was able to secure $750 million in cat bond form shows the depth of capacity in this market.”

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Ms. Klugman said that increased demand from investors for these securities is one of the primary dynamics propelling the market forward. In turn, increased investor demand means a better deal for issuers.

“Because we are seeing greater demand from investors, we are seeing tighter spreads,” she said. “So, for issuers this is now becoming a much more attractive economic alternative and a great complement to what they do on the reinsurance side.”

In addition to better prices, another trend making catastrophe bonds more appealing to sponsors is the manner in which the triggers used to activate the bond are constructed. While bonds triggered by parametric measures and modeled loss are still prominent, bonds that use indemnity triggers are increasingly common, Ms. Anger said.

Indemnity triggers, which are based on the losses suffered by the bond issuer, have gained popularity at the expense of both parametric triggers, which rely on measures such as wind speed to trigger the bond, and indexed triggers, which are based on an industry-wide index of losses.

“Many sponsors prefer indemnity-based coverages, and seeing the receptivity will be helpful in getting them to access this form of capacity,” she said.

Ms. Klugman agreed that wider use of indemnity triggers is a turning point for the market.

“One of the trends that made things more attractive for issuers is the fact that we are seeing an uptick in the number of bonds using an indemnity trigger,” she said. “Institutional investors are now more eager to take an indemnity trigger.”

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Ongoing advances in catastrophe modeling also have helped assuage investor concerns, Ms. Klugman said.

“Investors wouldn't be buying the bonds if they were not comfortable with the risk assessment being provided by the modeling firms,” she said.

Peter Nakada, New York-based managing director of risk markets at Newark, Calif.-based Risk Management Solutions Inc., one of the primary cat modeling firms used to model catastrophe bonds, said the market has finally reached critical mass nearly two decades after the first catastrophe bond was issued. Previously, a lack of catastrophe bonds failed to attract investors, while at the same time a lack of investors made the bond prices uncompetitive with traditional reinsurance, he said.

“In the old days, every cat bond was a snowflake,” he said. “That's not the way a market develops. Repeat issuers and standardized structures and documentation are what make a robust market.”

While the spike in catastrophe bond usage in 2012 is in some ways a reaction to the multiple catastrophes that occurred in 2011, it is also a validation of the inherent value of insurance-linked securities for insurance companies and investors, Ms. Klugman said.

“Sponsors truly value the collateralized and multiyear nature of the product, while for investors ILS products really make sense to add as an uncorrelated asset to their portfolio,” she said.