Rating agency Moody’s Investor Services has published a new version of its methodology and criteria for rating catastrophe bond transactions. The document, published yesterday, consolidates into a single document and replaces several older publications which defined Moody’s approach to rating cat bonds.
The document titled, Moody’s Approach to Rating Catastrophe Bonds, lays out Moody’s approach to rating catastrophe bonds and insurance-linked securities including extreme mortality ILS transactions.
Moody’s ratings of cat bonds address the ultimate receipt of cash promised to investors in terms of interest and principal in accordance with the specific terms and conditions laid out in a catastrophe bond transactions documentation. The rating is based on the expected loss to investors and Moody’s derives the rating from the likelihood that one or more catastrophe events will occur and the potential losses to investors from such events.
As well as the catastrophe exposure and expected loss within a cat bond transaction Moody’s rating also takes into account the credit strength of the counterparties in the deal, the credit risk of the collateral and the effectiveness of the transaction documentation in conveying the risks to investors and other parties.
Moody’s takes a four-step quantitative approach to rating catastrophe bonds:
- Assessing the promise made to investors;
- Examining potential loss scenarios and their associated probabilities;
- Calculating the expected losses for the catastrophe bond;
- Comparing the expected losses for the catastrophe bond to those of a set of benchmark notes.
If anything else is taken into consideration when rating a cat bond, which can happen if the deal is unusual or involves a new type of trigger or structural feature, Moody’s says it will disclose such considerations in the rating releases on the transaction.
As well as containing Moody’s rationale and methodology for rating catastrophe bonds, the document also provides a very good primer on the instruments themselves. You can access the full document from Moody’s here (you may need to register to download it).