S&P updates its catastrophe bonds rating criteria

Ratings agency Standard & Poor’s has published an update to one of its rating criteria articles related to natural peril catastrophe bonds and insurance-linked securities (ILS).

The updated rating criteria ‘Rating Natural Peril Catastrophe Bonds: Methodology And Assumptions‘ is the result of S&P refining and adapting its methodology and assumptions for rating natural peril catastrophe bonds and supersedes a May 2009 article ‘Methodology And Assumptions For Rating Natural Catastrophe Bonds’ and a September 2008 article ‘Approach To Rating Indemnified Natural Catastrophe Insurance-Linked Securities’.

With the publication of the article, S&P hopes to assist market participants to gain a better understanding of its approach to rating catastrophe bonds.

The new criteria article aims to provide a framework for rating a cat bond, while giving S&P the opportunity to clarify a number of areas from the old criteria and to reflect new developments in the cat bond and ILS market.

The fact that S&P, who get to assess the majority of catastrophe bonds and ILS deals which are submitted for rating, feels the need to update its criteria shows that the market is evolving. In this update S&P has taken the opportunity to add information about new structural features that have been used in catastrophe bonds recently.

One such feature that the criteria now considers is the variable reset, which allows a sponsor to elect to reset its cat bond with a different probability of attachment to when the transaction was launched, as a result of which the coupon paid to investors is also amended to reflect the change in risk.

The criteria also now;

• Addresses the insulation from credit risk where the transaction sponsor or cedent is unrated.
• Explains the treatment of partial-year risk periods which are based on the time to reset or maturity, unless the peril is seasonal.
• Sets forth the additional information needs for transactions that define the covered event “Named Storms” instead of “Hurricanes.”
• Addresses the impact of coupon stepdowns.

The updated criteria also seeks to clarify:

• The methodology used to assign a rating.
• The stresses applied to the model results.
• The impact of counterparty exposure.
• Separately from the criteria, the appendix describes certain aspects of the surveillance process.

Standard & Poor’s said that the update to the criteria would have no impact on any outstanding ratings of catastrophe bond transactions.