A derivative contract which is primarily used for hedging purposes by insurance firms. Such a derivative is designed to provide protection against adverse events and catastrophic risks such as earthquakes, floods, hurricanes, etc. Reinsurance contracts are used to encounter possible hazards by covering exposures on pro rata basis.

The reinsurance contract is technically known as an excess-of-loss reinsurance contract and is analogous to writing a bull spread on the total losses incurred by the reinsurance company. In other words, it is like long a call option in which the exercise price is equal to the lower bound of the excess cost layer and simultaneously short a call option whose exercise price is equal to the upper bound of the excess cost layer.

A CAT bond is a typical example of insurance derivatives.