AIR Worldwide’s new flood model could help the flood cat bond cause

We’ve written a lot about the potential for flood risks to be structured and sold as catastrophe bonds on Artemis. You can read some of our more recent articles on this topic here and here. Still there is no sign in the cat bond pipeline of anyone putting together a flood cat bond but we’re still convinced it will happen within the next year or two. One of the issues holding back flood risks from being issued as cat bonds has been the availability of models, but a new one from AIR Worldwide could help to move the cause forwards.

AIR Worldwide recently launched a new inland flood model for Germany which offers “a fully probabilistic approach for determining the likelihood of flood losses from all types of storms”.

The new model contains some innovations which make it much more suitable for use in catastrophe bond transactions. “To meet the challenge of capturing both large-scale and small-scale precipitation patterns, AIR has adopted the innovative approach of coupling a state-of-the-art Global Climate Model (GCM) with a detailed Numerical Weather Prediction (NWP) model,” said Dr. Jayanta Guin, SVP of research and modeling at AIR Worldwide. “The result is a sophisticated model that simulates realistic and robust storm patterns over space and time, allowing companies to manage their risk from flooding both on and off the floodplain.”

The model also accounts for both liquid and frozen precipitation, snow melt, soil moisture and takes into account surface wind, surface temperature and solar radiation. It is certainly one of the most robust flood models we’ve come across.

Other items of interest in the new model include:

• A state-of-the-art approach accounts for the impact of topography and terrain on regional precipitation fields at high-resolution for improved risk selection and better assessment of portfolio risk.
• Topography, soil type, geology, urbanization, and other local factors are used in calculating precipitation runoff throughout the river network.
• A physically based hydraulic model transforms river discharge to water level, or elevation. This step is critical for assessing inundation depth at each location of interest for each event and ultimately for determining loss.
• A component-based approach — one that divides a building into building fabric, fixture and fittings, and services — helps estimate the vulnerability of commercial buildings and their contents.
• Flood defenses play a critical role in protecting properties within Germany’s floodplains. The AIR flood model accounts for flood defense structures such as levees, dikes, and flood walls using a probabilistic approach that incorporates the most prominently used standards of flood protection. The model also supports custom flood defenses, which is particularly useful for accurately assessing the risk to high-value properties such as industrial facilities.
• The model supports the evaluation of reinsurance contracts incorporating a 504-hours clause as well as other durations.
• Extensive analyses of detailed loss experience data, including that from the 2002 Elbe floods, provide validation.

We asked AIR Worldwide whether they felt this model could be used to perform modelling and assist with structuring a flood catastrophe bond. Brent Poliquin, Senior Risk Consultant at AIR Worldwide commented;

“ILS investors are hungry for new transactions covering different region/peril combinations in order to further diversify their portfolios. Germany inland flood is currently not covered in the ILS space to date, yet when there is a credible catastrophe model in place, the risk is better understood and invites the development of new transactions covering this peril. No matter what type of alternative risk transfer structure is being considered – parametric or even indemnity trigger-type transactions – a comprehensive catastrophe model can provide the most realistic view of the risk available in the marketplace.”

So, certainly AIR feel that their model could be used in a German flood risk cat bond. Now all we need is an insurer or reinsurer with sufficient German flood risks on their books to take the plunge. Any German flood cat bond that came to market would likely be extremely popular among investors given it would be a completely new risk for them to diversify their portfolios with.