Catastrophe bond ratings on watch due to new RMS hurricane model

Ratings agency Standard & Poor’s has placed the ratings of 16 tranches of catastrophe bond deals on CreditWatch negative due to recent changes in the risk model which was used to assess these cat bonds risks at the time of their issue. All the affected transactions utilise the Risk Management Solutions (RMS) RiskLink U.S. hurricane risk model which was recently upgraded.

We’ve been waiting to see what the impact would be on cat bonds which utilise this risk model, it seemed likely that some announcement would be forthcoming from a rating agency to explain how they saw the new model impacting the credit quality of these deals. The changes in the upgraded RMS risk model have led to a different risk profile for many U.S. states which has increased the modelled potential loss on some of these cat bonds. S&P says that the changes to the risk model means that the modelled trigger point for the transactions may differ under the new model and as a result they are requesting that RMS re-model the transactions using the new version.

S&P stated in a press release today:

However, recent conversations with and information from RMS indicates that if the company re-modeled existing  transactions with RiskLink V11, the results could be materially different from what the existing models had yielded. Some of the changes in the model are higher inland wind speeds, increases to building vulnerability, updates to  secondary modifiers (such as roof type and construction), and increases in storm surge modeled losses. Some of the effects of these model changes are that:

• Loss estimates are expected to increase for all return periods.
• Losses on commercial exposures are increasing more than on residential.
• Losses in Florida show smaller increases than in other regions, losses in Texas increase the most, and losses in other states increase in varying degrees.

S&P have requested that RMS, using the new RiskLink V11,  provide them with the information they require to re-assess each cat bond. S&P will publish their results and findings for each deal and whether or not the new assessment results in any ratings changes.

S&P say that they expect any ratings changes to be within one and three notches, though it is possible for changes to be greater or for there to be no change at all. They expect to complete the analysis on these deals by the end of May.

RMS’ new hurricane risk model has received some controversial press because some of the risk estimates in certain states and areas have risen significantly compared to the older version. This has led some to believe that rate rises and cost increases are bound to follow for which policyholders will be picking up the bill. RMS’s response to these concerns can be found here.

It’s understandable that as a result of the substantial change S&P want to ensure that the rating they give to catastrophe bond transactions which utilise the RMS hurricane model are correct.

The affected catastrophe bond transaction tranches are:

• Ibis Re Ltd.
  Series 2009-1 Class A notes
  Series 2009-1 Class B notes
  Series 2010-1 Class A notes
  Series 2010-1 Class B notes
• Lodestone Re Ltd.
  Series 2010-1 Class A notes
  Series 2010-1 Class B notes
  Series 2010-2 Class A-1 notes
  Series 2010-2 Class A-2 notes
• Montana Re Ltd.
  Series 2009-1 Class A notes
  Series 2009-1 Class B notes
  Series 2010-1 Class C notes
• Foundation Re III Ltd.
  Series 2010-1 Class A notes
• Longpoint Re II Ltd.
  Series 2009-1 Class A notes
  Series 2009-1 Class B notes
• Calabash Re III Ltd.
  Series 2009-1 Class A notes
  Series 2009-1 Class B notes

S&P note that one class of Montana Re notes are already on CreditWatch negative due to the Japan earthquake. If that event activates this second event bond then it could still be subject to a rating change depending on their findings after analysing the impact of the RMS model update.

All tranches remain on the same rating as when they were issued but with a CreditWatch negative sentiment. Details of all the above cat bond transactions can be found in our Deal Directory.

We’ll update you on any future rating changes for these catastrophe bonds once S&P have completed their analysis and published the results.