ILS = Insurance-Linked Securities

ILS are financial instruments usually sponsored by insurers or reinsurers to cover extreme natural events which can affect them from a financial standpoint. They are therefore willing to pay investors a coupon to hedge against this risk.

At maturity, the principal is returned provided that the insured event was not significant enough to trigger any loss payment. If the insured event was triggered, investors might face a partial or total loss of their principal. 

ILS investors are therefore acting as reinsurers. It is a typical example of a capital market risk transfer. ILS are a great source of diversification as their performance does not depend on financial market behaviour.