New Aon model to enhance ILS’ view of U.S. severe thunderstorm risks

A new, U.S. severe thunderstorm (STS) scenario model has been launched by Aon Benfield’s catastrophe model development team, Impact Forecasting, which will assist sponsors and investors in the catastrophe bond space to better understand U.S. thunderstorm risks.

Insurers, reinsurers, and insurance-linked securities (ILS) players now have access to 7.5 million U.S. severe thunderstorm scenarios following the release of a new model from Aon, called STS RePlay.

“STS RePlay leverages existing data and approaches it in a new way to better understand the actual extent of current loss behaviour, allowing for more informed decisions for policy and rate makers,” said Impact Forecasting Director, Steve Drews.

During the last ten years (2006-2015) Aon explains that U.S. severe thunderstorms have become an increasingly costly peril for U.S. re/insurers on an average annual basis, overtaking tropical cyclone in terms of costs.

While the catastrophe bond and ILS market is continuing down its impressive growth path, in order for it to expand its reach and have a greater influence on both developed and emerging markets, enhanced modelling and analytics will likely prove invaluable.

“Over the last decade, severe thunderstorms have contributed towards an increasingly large portion of the insurance industry’s global catastrophe losses.

“The roll out of Impact Forecasting’s new STS model now means that insurers and reinsurers can effectively manage their risk and use the model’s transparency to explain the details of their loss numbers and create their own view of risk from this peril,” said Stephen Hofmann, Executive Managing Director at reinsurance broker Aon Benfield.

The new tool from Aon will provide ILS participants with a better understanding of U.S. thunderstorm risks, an exposure that is a growing section of the cat bond space with the recent rise of multi-peril deals.

In fact, data from the Artemis Deal Directory reveals that during 2015 $1.125 billion, or roughly 14%, of the $7.898 billion in catastrophe bond issuance was exposed to U.S. severe thunderstorms.

The $1.125 billion of U.S. severe thunderstorm exposure issued during last year comes from five deals, covering six tranches of ILS notes.

This includes two deals from one of the cat bond sector’s most prolific issuers, USAA, a $150 million Residential Reinsurance 2015 Ltd. (Series 2015-1) U.S. multi-peril deal, and its $125 million Residential Reinsurance 2015 ltd. (Series 2015-2) U.S. multi-peril transaction.

A $300 million U.S. multi-peril deal from Travelers via its Long Point Re III Ltd. (Series 2015-1) platform, $250 million of U.S. multi-peril protection from Chubb with its East Lane Re VI Ltd. (Series 2015-1) transaction and, $300 million of multi-peril protection aimed specifically at covering events in Massachusetts via Cranberry Re Ltd. (Series 2015-1), from Massachusetts Property Insurance Underwriting Association / Hannover Ruck SE.

Notably, none of the above deals cover U.S. severe thunderstorm risks as a stand-alone peril, with each deal covering multiple U.S. or multiple international exposures, further highlighting the growing trend of multi-peril cat bond and ILS transactions in recent times.

However, advancements with modelling tools and analytics as seen with Aon’s STS model launch, could enable a stand-alone U.S. severe thunderstorm cat bond to come to the market, as the exposure is better understood by investors and sponsors alike, resulting in improved pricing and risk assessment capabilities.

Where it differs from models that are currently used across the industry to assess U.S. severe thunderstorm risks, explains Aon, is with reporting and modelling aggregated severe thunderstorm events, something current models typically underreport, says Drews.

“Stochastic models have historically underreported aggregate losses due to a lack of hail and convective wind historical data,” explained Drews.

An aggregation of losses from severe thunderstorms can diminish insurers and reinsurers’ balance sheets over the course of a year, as the risks might not be fully, or accurately accounted for in probabilistic models that aim to “identify the most probable maximum loss from a single event,” explains Aon.

In an effort to bridge this gap, the new STS RePlay model utilises 12 years of historical U.S. severe thunderstorm data from the Storm Prediction Centre, and then replayed that data to develop some 7.5 million scenarios that can be used to determine average annual losses.

As Aon underlines, the new model should be used to supplement a probabilistic model by “drilling down to the annual average loss in addition to the probable maximum loss,” which will surely only give the client a more comprehensive view of U.S. severe thunderstorm exposures.

This could lead to more “informed reinsurance purchasing and underwriting decisions,” while also enabling insurers, reinsurers, and we’d hasten to add ILS players, to expand into new U.S. regions, explains Aon.

The ILS and cat bond space will likely greatly benefit from Aon’s new tool, enabling participants to better asses their exposures to a growing part of the marketplace.

Furthermore, as ILS continues to spread and influence a greater share of the overall reinsurance landscape funds and managers are becoming more exposed to frequency events, which includes U.S. severe thunderstorms – the STS RePlay tool could offer greater understanding of the potential for an aggregation of losses, and how to account for this in their portfolio to minimise exposures.

Any new, comprehensive tool, or model for well-understood or misunderstood perils will be welcomed by insurers, reinsurers, and ILS market participants, as they improve the understanding of that peril and increase transparency and hopefully efficiency in a market that is seeing the frequency of catastrophe events rise.