One of the key elements of any catastrophe bond trigger needs to be a transparent, rapid and fair payout process. This is especially true for parametric of index triggers, where a third-party may be reporting data on which decisions over losses are made.
This brings us to an interesting aside to the announcement of the National Hurricane Center’s final tropical cyclone report for hurricane Patricia yesterday, which promises to bring forward the final determination of any payout being made by investors in the stricken $100m tranche of MultiCat Mexico Ltd. (Series 2012-1) Class C catastrophe bond notes.
The report shows a landfall minimum central pressure of 932mb for hurricane Patricia when it reached the Mexican coastline. This number is right on the lower end of the range required for a 50% loss of principal to be triggered for the $100m tranche of notes.
However, that is the landfall pressure reported by the NHC and the parametric trigger zone begins offshore, when it is likely the pressure was lower. That should signal an almost certain 50% loss of principal to the notes, with still the potential (albeit small) for a 100% loss if the interpolation of the pressure by calculation agent AIR Worldwide found that the pressure rose really quickly on the way to the coast.
However, one of Artemis’ contacts (Mark Guishard of the Risk Prediction Initiative at the The Bermuda Institute of Ocean Sciences Inc.) brought it to our attention today that the NHC has added a level of uncertainty into that 932mb pressure reading.
The 932mb is a figure reached by analysing all the data from the storms track, any readings taken on land and any additional inputs that are available. The NHC studies these and comes up with what it calls its ‘best track’ for a specific storm, which is (we believe) where the pressure reading for the MultiCat calculation process is taken from.
So the best track information in the NHC’s report does read 932mb at landfall. However, in the report the NHC has noted a level of uncertainty in this figure.
The NHC explains that it infers the 932mb from data sources including observations by automated weather stations and a storm chasers data, but with the caveat that this is “with the uncertainty of this value likely on the order of 2-3 mb.”
The NHC’s full explanation is below and the report is available here (PDF format):
Operationally, Patricia was assessed to have been of category 5 intensity with a landfall pressure of 920 mb, but a post- analysis of additional data obtained later suggests that the hurricane had weakened more rapidly than estimated in real time. A minimum pressure of 934.2 mb was observed around 2300 UTC by an automated weather station at Playa Cuixmala, located on the coast near Emiliano Zapata. Although the wind data from this site failed near landfall, a temperature spike to 28 ̊ C was recorded, suggesting that the eye passed close to this location. A storm chaser in Emiliano Zapata, a couple of nautical miles inland from the landfall point, measured a minimum pressure of 937.8 mb on the eastern edge of the eye at 2313 UTC with simultaneous winds of near tropical storm force. The automated weather station in Pista, located about a mile north-northeast of Playa Cuixmala, measured a station pressure of 939.4 mb at an elevation of 15 m, which converts to a sea level pressure of 941.0 mb. The wind data for this site indicate that the station never experienced a calm, and thus the winds at the time of the minimum pressure are unknown. A plot of these pressures for comparison is given in Figure 8. A minimum central pressure of 932 mb at landfall is inferred from these data, with the uncertainty of this value likely on the order of 2-3 mb. The 932 mb analyzed landfall pressure is the lowest central pressure for a landfalling Pacific hurricane in Mexico in the historical database.
So, the figure that is the basis for the determination of whether the MultiCat Mexico 2012 Class C cat bond notes face a loss or not is subject to 2mb or 3mb of uncertainty, according to the NHC. How could that affect the interpolation of the track and the pressure of hurricane Patricia?
Now, we must note here, that the calculation process and cat bond offering documentation state that the pressure figure must come from “the best track data set known as HURDAT from the NOAA.”
The calculation agent than runs its process, using linear interpolation to identify how the pressure changed along the storm track, using this best track data set, to work out what the pressure was when the storm was within the parametric trigger zone.
So it seems clear that the HURDAT best track figure is the 932mb at landfall. However, the fact that the NHC has mentioned uncertainty just makes things a little less clear, which is not particularly helpful. It’s also a little unusual for the tropical cyclone reports to reference uncertainty in the best track pressure figures.
As we said in the title this is unhelpful in the case of the MultiCat cat bond, although likely not an issue. It simply shows that the trigger design is perhaps not optimal, although perhaps the best available at the time in 2009 when the first MultiCat cat bond was issued and the structure used again for this 2012 deal.
Investors and any participants in the cat bond will expect a clear-cut decision and while it still looks like it is possible to make one, as the best track data will be used as stated in the transaction terms, the uncertainty bounds that the NHC has put around its landfall pressure figure just make things a little less satisfactory, from a transparent and rapidly settling parametric trigger point of view.
Also read all our coverage of hurricane Patricia and the MultiCat cat bond (most recent first):