Guide
Protection Swaps
How OTC bilateral protection swaps work, how they differ from insurance and listed options, ISDA master agreement implications, and institutional use cases including key-person, regulatory, and revenue protection.
What is a protection swap?
A protection swap is an OTC bilateral agreement in which one party (the protection buyer) pays a periodic premium and the other party (the protection seller) agrees to make a fixed payment if a specified event occurs. The structure is economically similar to insurance but is documented as a swap under ISDA framework agreements, regulated by the CFTC rather than state insurance commissioners, and available only to eligible contract participants (ECPs).
The "event" referenced by the contract can be anything objectively measurable and resolvable — a regulatory decision, a credit rating action, a weather outcome, an executive departure, a legislative vote. This flexibility is the primary advantage over insurance, which is limited to "insurable interests" under state law.
Structure of a protection swap
A standard protection swap has four components:
- Reference event. The specific, objectively-defined event that triggers the protection payment. (Example: "The FDA issues a final rule restricting X by December 31, 2027.")
- Notional amount. The maximum payment the protection seller will make if the reference event occurs. Sized to cover the buyer's estimated loss.
- Premium. The periodic payment from buyer to seller. Can be structured as a fixed upfront amount, ongoing daily/monthly payments, or a combination.
- Resolution mechanism. How the occurrence of the reference event is determined — typically a designated oracle, regulatory publication, or independent verification agent.
Protection swaps vs. insurance
Protection swaps and insurance are economically similar but legally and structurally distinct:
| Feature | Insurance | Protection Swap |
|---|---|---|
| Regulatory regime | State insurance law | CFTC / Dodd-Frank Title VII |
| Reference event | Insurable interest required | Any objectively resolvable event |
| Documentation | Insurance policy | ISDA Master Agreement + confirmation |
| Counterparty | Licensed insurer | Any ECP bilateral counterparty |
| Transferability | Generally not assignable | Novatable with counterparty consent |
| Mark-to-market | None | Daily MTM via CSA if applicable |
| Dispute resolution | State insurance commissioner | ISDA dispute resolution / arbitration |
The ISDA master agreement
Protection swaps are documented under an ISDA Master Agreement — the standard legal framework used for OTC derivative transactions globally. The ISDA framework provides standardized definitions for termination events, credit support, netting, and dispute resolution.
For first-time participants, negotiating an ISDA can be a weeks-long process involving legal review of dozens of elections and definitions. Tomorrow's ISDA war room accelerates this with AI agents that draft, redline, and negotiate standard elections on your behalf — compressing the documentation phase from weeks to hours.
Key ISDA elections that affect protection swaps include:
- Governing law. New York law is standard for US-domiciled counterparties.
- Automatic early termination. Whether the swap terminates automatically upon insolvency of a party or requires notice.
- Credit support annex (CSA). Whether collateral (variation margin) is exchanged to mark positions to market — critical for long-duration swaps.
- Netting. Whether all swaps between the parties can be netted into a single net payment on termination — reduces counterparty credit exposure.
Key-person protection swaps
The most common protection swap on Tomorrow's platform covers key-person risk: the risk that a critical individual (founder, CEO, portfolio manager, lead scientist) leaves, is incapacitated, or otherwise becomes unavailable.
Unlike life insurance, a key-person protection swap can be triggered by events other than death — resignation, permanent disability, regulatory bar, or loss of licensure. This makes it suitable for covering the full spectrum of human-capital risk that affects institutional investors and portfolio companies.
Typical structures include:
- Binary payout. Full notional paid if any covered event occurs. Simple, easy to value.
- Tiered payout. Different notional amounts for different events (e.g., $5M for resignation, $20M for incapacitation). Allows premium calibration to severity.
- Duration-limited. Protection for a defined window (e.g., 18 months ahead of a Series C close), after which the swap terminates.
Regulatory framework
Protection swaps between ECPs are regulated as swaps under the Commodity Exchange Act, specifically Title VII as enacted by Dodd-Frank. Key regulatory requirements:
- Both parties must qualify as ECPs (institutions with assets exceeding $10M, or individuals with $10M in investments).
- Swaps above the de minimis threshold ($8B aggregate notional for dealers) require registration as a swap dealer. Tomorrow's facilitation model is structured to keep individual counterparty notionals below this threshold.
- OTC swaps between ECPs that do not involve a swap dealer are exempt from mandatory clearing and exchange execution requirements under Section 2(h)(7) of the CEA.
Structure a protection swap
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