In our latest interview we spoke with Peter Nakada, Director of RiskMarkets at Risk Management Solutions (RMS) the risk modelling firm who provide services and expertise for the quantification and management of catastrophe risks.
From a risk modelling firms point of view, how do you think the insurance-linked security and catastrophe bond markets are fairing?
We believe that the insurance-linked securities (ILS) and cat bond markets have continued to evolve positively. The financial crisis actually helped improve the asset class, as collateral structures are now simpler, and involve less credit risk. In addition, investors saw firsthand the value of a low correlation asset class during a financial crisis, which attracted new pension money to the space, and bodes well for further growth.
However, we remain convinced that the asset class has not yet reached its “tipping point” – the point at which ILS becomes the preferred means of financing peak peril catastrophe risk. We believe that the asset class will remain attractive to pension investors as the supply of new pension fund capacity narrows spreads. At the “tipping point” it becomes cheaper for insurers and reinsurers to transfer the bulk of their peak peril risk to the capital markets – resulting in a market 5-10x as big as it is today.
Risk modelling and analysis plays a big role in these markets. How do you see that role now and how do you think it could evolve in the future?
RMS and the other catastrophe modelling firms play a unique role in the fixed income world. To the best of our knowledge, we are the only asset class where a full risk analysis is “expertised” and included in the offering materials. For other fixed income asset classes, the offering materials are a description of how the security works, and accountants ensure that the security description is correct.
We envision that, as the ILS market matures, it will start to look more like traditional asset classes – where the offering materials describe the structure of the security, and the risk analysis is provided to investors through analyst reports and software. We have begun to move to this model by providing our clients with Miu, our ILS portfolio management platform, and our own expert commentary on every cat bond issued.
What innovations are happening in the risk modelling and analysis world right now? Are there any emerging technologies you can see having an impact in future?
For many years, we relied on Moore’s law to drive advances in how much insight we could derive from catastrophe modelling, while still being able to run the models in a reasonable amount of time. We are now beginning to utilize emerging technologies that will allow us to “jump the curve” to greatly improved performance and analytical insights: grid computing, graphics processing units (gaming chips), and cloud computing all lend themselves to improving cat modelling performance.
In addition, we have made great strides in being smarter about our analyses. We are improving our ability to “ration complexity” in the catastrophe models, so that we spend our analytical horsepower where it will provide the most actionable insights.
All of this adds up to faster access to better information for investors.
Tell us a bit more about the RMS suite of products and how they can benefit ILS issuers and investors?
RMS offers two products for the ILS market: Miu and Paradex. Miu is a combination of software and service that allows portfolio managers to manage portfolios of ILS and collateralized reinsurance. Miu is a purpose-built portfolio management platform, not a catastrophe model adapted for portfolio management. Investors benefit in two ways:
- Security selection – Miu users get an RMS view of risk in most cases before they need to make investment decisions. We provide “first look” notes on new issuances, whereby we provide our observations on the structure and risk analysis before analyzing the security in detail. We then provide the full characterization of the deal in Miu, which allows users to understand standalone risk, scenarios/stress tests, and risk contribution to their portfolios.
- Portfolio management – Miu users can understand the total risk of their ILS portfolios, as well as the marginal contributions of risk from each security.
Paradex is a suite of parametric indices that issuers can use for structuring transactions. These indices can be tailored to minimize basis risk for the issuer, but also provide simplicity and transparency for investors.
RMS provide risk analysis on pandemics, longevity and mortality. Do you see these as areas of growth for ILS?
We are bullish on the prospects for growth in the life and health ILS market. As Solvency II has begun to take hold in Europe, we have seen demand from life insurers to measure their tail exposure to both mortality and longevity more carefully – avoiding the “conservative” treatment they would otherwise need to take to satisfy regulatory requirements. We expect this will motivate transactions in both excess mortality and longevity.
We are encouraged by our success in helping Swiss Re to get their Kortis longevity cat bond rated by Standard & Poors. We expect that this will open the door for more rated longevity cat bond transactions, especially for UK pension funds (where accounting and regulatory treatment of pension liabilities make potential longevity improvements particularly risky).
What other areas of growth for ILS can you foresee? Are there any specific new perils or lines of business you think will be included in ILS transactions in the future?
We believe that the capital markets are best suited for taking peak peril catastrophic risk – so it will be the lines of business with the largest loss potential (and therefore highest risk concentration) that are likely to find their way into the capital markets. One of the possibilities that we have looked into is ‘liability catastrophe’ risk – mass tort risk arising from sources such as product liability.
RMS have worked on terrorism risk models. Do you think we will ever see terrorism risk transferred to the capital markets?
Golden Goal Finance Ltd was the first securitization to cover terrorism risk, in addition to natural perils. It was structured using RMS analysis to cover cancellation of the 18th FIFA World Cup™ in 2006 in Germany.
We believe that terrorism represents a peak peril that could benefit from diversification into the capital markets. We believe that over time investors and rating agencies will become more comfortable with the concept of being able to quantify the probabilities of terrorist attacks, which should open up capital markets demand.
Do you foresee any of the current regulatory changes (such as Solvency II) impacting risk modelling for the ILS market?
Solvency II will likely impact modelling for the ILS market in that insurers will be required to use the same model for their internal capital management as for their risk transactions.
Do you have any thoughts or predictions for the future of the insurance-linked security and catastrophe bond markets?
We still believe in the potential of an ILS market that creates $50 billion per year of new issuance.
Our thanks go to Peter Nakada for his time and insight into the risk modelling world and how it relates to insurance-linked securities and catastrophe bonds.