AIR launches U.S. inland flood model, could bring more flood risk to ILS

by Artemis on October 6, 2014

Catastrophe risk modelling firm AIR Worldwide has announced the launch today of what it is calling the industry’s first detailed, physically based, probabilistic inland flood risk model for the United States.

The new inland flood model is designed to provide insurers, reinsurers and other industry stakeholders with what AIR terms a “comprehensive tool for assessing and managing inland flood risk at a high resolution for locations on and off the many and varied floodplains across the United States.”

“Until now, the industry has lacked the tools to effectively quantify flood risk in the United States,” commented Dr. Jayanta Guin, executive vice president of AIR Worldwide. “We’re excited to bring this game-changing modeling solution to market. It’s a major step forward in helping the industry manage this complex risk by better understanding the severity, frequency, and location of potential flood events.”

AIR hopes that the new model will provide value across the insurance and reinsurance value chain, as well as offering benefits to risk managers looking to identify at-risk assets and design risk transfer strategies.

The flood model will also be of benefit to the insurance-linked securities (ILS) market, as ILS managers are already deploying capital into reinsurance programmes containing flood risk and this risk model will assist them in better understanding their exposures, pricing the risks and designing structures to transfer flood risk to the capital markets.

AIR Worldwide explains:

The AIR Inland Flood Model for the United States defines flood events based on a physical understanding of what causes flooding and how floods propagate through the country’s extensive river networks. The model captures inland flood risk for all 18 hydrological regions across the contiguous United States, an area of approximately 3 million square miles with a river network 1.4 million miles long, including 335,000 distinct drainage catchments.

The model simulates both the weather systems and the flooding they cause and accounts for a broad range of climatic conditions, snowmelt, local soil conditions, land use, and topography. Simulated flood propagation accounts for the effects of more than 20,000 lakes and reservoirs. Damage is determined by calculating the inundation depth at each affected location, taking into account the country’s extensive system of levees and their probability of failure, as well as regional differences in building codes and building practices.

In addition to accounting for flooding that will occur next to the river, AIR also incorporates flood hazard that can happen away from the river, known as off-floodplain flooding. This can happen because of factors such as particularly intense rainfall and poor drainage, among other factors.

AIR’s innovative approach to simulating rainfall couples a global Community Atmospheric Model (CAM) with a regional Weather, Research, and Forecasting (WRF) model. The results are realistic and statistically robust storm patterns over space and time. A sophisticated downscaling technique enables the model to capture both large- and small-scale precipitation patterns, including the bursts of extreme rainfall that contribute greatly to highly localized flooding.

The AIR model also uses a physically based hydraulic model that calculates the extent of flooding and the depth of inundation at each location of interest on the floodplain. This unique hydraulic model accurately accounts for local terrain characteristics and generates a physically consistent delineation of floodwater extents.

AIR is using its new flood model while taking part in an important study that could stimulate greater transfer of U.S. flood risks to the private insurance, reinsurance and capital markets. AIR is participating in FEMA’s “Flood Insurance Risk Study”, assessing the potential of the private sector, including insurers, reinsurers, ILS and capital markets, to take on portions of the currently government assumed flood risk. AIR says that its probabilistic U.S. inland flood model is fundamental to this study.

This FEMA study will be looking at the possibility of using instruments such as catastrophe bonds as one way to transfer some of the peak U.S. flood risks to the capital markets. With ILS investor appetite for new risk strong, any successful efforts to move flood risk out of the National Flood Insurance Program and into the capital markets will be extremely well received.

“The AIR Inland Flood Model for the United States represents one of the most challenging and innovative research development efforts in AIR’s history,” said Dr. Guin. “This state-of-the-art model accounts for the unique circumstances that contribute to flood risk across the country. It provides insurers with a highly detailed, physically based, probabilistic approach for underwriting and helping to manage this complex risk on and off the floodplain and for uncovering new opportunities in the evolving flood insurance market.”

Having a flood model available for the inland U.S. could be a huge benefit for ILS investors and managers looking to find new ways to deploy capital and diversify their portfolios. If U.S. inland flood can be modelled to a degree that ILS capital can be applied in increasing quantities it could have the potential to become a key peril within the ILS space.

Rob Newbold, SVP, Business Development and Consulting & Client Services at AIR, recently told Artemis “The flood model has applicability for ILS we believe.” Newbold explained that the flood model could be used both for parametric transaction structures, but also he feels for an indemnity catastrophe bond transaction as well.

“We feel it’s ready for indemnity and is suitable for modelling a transaction based on a cedents portfolio. It could also be used for creating and modelling localised parametric products,” Newbold said.

Whether a flood catastrophe bond could be structured using the AIR inland flood model will take time to establish, but we’d imagine that some brokers and structuring agents will begin looking at this possibility straight away. If flood risk could be modelled to a high-enough resolution and with sufficient granularity to get ILS investors comfortable with the risk, it could be a game-changing development for the ILS market.

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