RMS release set of benchmark catastrophe bonds to help compare models

by Artemis on May 16, 2011

Risk Management Solutions have released a set of model benchmark catastrophe bonds which have been designed to compare how risk models from different vendors (or different models versions from the same vendor) perform. The benchmark cat bonds will provide a standardised structure against which to compare the analysis that risk models output.

The bonds are a set of simple, representative insurance-linked security structures which RMS say can be run in any of the major catastrophe models. They will give prospective clients another tool to allow them to test the various risk models and how using one over another can affect the risk profile of a cat bond.

The first set of benchmark cat bonds cover two perils which are regularly issued as cat bonds, U.S. hurricane and U.S. earthquake and are structured as both industry loss and standard exposure transactions. The bonds have been designed in cooperation with insurance-linked securities investment specialist Fermat Capital Management LLC. RMS said today that the standard exposure bond is derived from public census data meaning that no proprietary information is required to perform the modeling.

It’s understood that RMS have released these standardised cat bond structures to help their risk models be compared to other vendors, particularly important given the release of their new U.S. hurricane risk model which has had the market talking lately. They held a conference call today to discuss some of the issues raised around the new hurricane model and announced that on average the expected loss for outstanding U.S. hurricane exposed cat bonds will rise 90% when analysed through the new model with industry loss triggered deals the most impacted. That’s a huge jump and the figure is certain to cause some nervousness in the market as to whether investors will accept that large an increase in expected loss.

The announcement of such a large increase in expected loss for existing hurricane cat bonds is sure to have ratings agencies Standard & Poor’s and Moody’s assessing the cat bonds they rate to see if any rating action is required. We wrote recently about their comments that they wanted to see how existing cat bonds performed through the new model and that the results could equate to rating actions on affected bonds (Moody’s comments here, S&P’s comments here).

It’s going to be an interesting run up to U.S. hurricane season as the market fully digests the impact (if any) of the new risk model and raised expected loss figures. As we wrote last week, average expected loss characteristics have been rising steadily since the inception of the catastrophe bond market in 1997 anyway, so this rise may not have as much impact on the market as some suggest. It will put the emphasis back on structuring specialists to cleverly create transaction terms which keep expected loss and risk profile to a minimum.

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