RMS to use long-term rate model of hurricane activity for catastrophe bond transactions

by Artemis on July 26, 2012

Risk modelling firm RMS have announced that as part of an initiative they are undertaking to help educate on the uncertainties inherent in catastrophe modelling they are moving to a new way of presenting hurricane risk within insurance-linked securities and catastrophe bond transactions. The change is a response to clear signals RMS say they have received from the ILS market.

The change will see RMS begin to use the long-term rate model to produce its Reference View of risk and the medium-term rate model as a sensitivity test for insurance-linked securities and cat bond offering circulars. They say that the ILS market has clearly signaled that RMS’ long-term rate model of hurricane activity is more useful in facilitating hurricane cat bond transactions than its medium-term rate model.

RMS say that this is part of its Resilient Risk Management initiative, which they are undertaking to help catastrophe risk managers understand the uncertainties inherent in catastrophe modelling, understand the impact of different parameter assumptions on the results, and tailor model parameters based on how the results are being used.

It’s encouraging to see that RMS are listening to the market and trying to adopt a methodology for modelling hurricane cat bonds that the market believes is more useful. This is clearly a response to the backlash RMS have felt since launching the latest version of their U.S. hurricane model last year, which has seen them drop from being the most prolific modeller of hurricane cat bonds to not modelling a single hurricane exposed ILS deal since. By listening to market participants and utilising the long-term view of hurricane risk they must be hoping to start picking up transactional modelling work again. RMS is of course one of the most widely used models in the wider re/insurance industry anyway, so there has to be a role for them in hurricane cat bond modelling if they can get the market comfortable with their view of the risk again.

In addition to this change, RMS have also announced today that they will add a scenario to offering circulars that assumes only 10 percent of modelled storm surge losses ‘leak’ into residential and commercial low-rise wind-only policies. The aim of this is to help investors understand storm surge sensitivity, an area of concern in some cat bond transactions, and assist in comparison of this risk with other available catastrophe models.

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