Verisk working to refine traditional cat-in-a-box structure

Verisk Insurance Solutions is working on enhancing the traditional parametric cat-in-a-box structure, aiming to minimise basis risk and expand its capabilities, which in turn could create opportunities for the reinsurance and insurance-linked securities (ILS) markets to deploy more capacity.

Working alongside Wood Mackenzie, a fellow Verisk Analytics company, Verisk Insurance Solutions is looking to increase the capabilities of the traditional cat in a box protection structure, in an effort to enable the abundance of reinsurance linked capacity to better reach underserved sectors such as offshore energy.

In a recently published report on the Q1 2016 catastrophe bond market, Verisk explains that while the cat in a box structure is “a simple solution to a complex problem,” many in the sector are more than aware of its limitations, especially when it comes to the basis risk.

With a traditional cat in a box structure grid coordinates are plotted and a storm magnitude is identified such as wind speed or hurricane category, then, should the storm pass through the pre-defined grid at the designated magnitude, the protection is triggered.

So it really is a simple structure that has enabled capacity for catastrophe risks to be brought to regions like the Gulf of Mexico, but its limitations have hindered its expansion and broader adoption, says Verisk.

Tom Johansmeyer, Assistant Vice President, Reinsurance Services, Verisk Insurance Solutions said; “We’re aware that the Wood Mackenzie-enabled cat in a box structure is being discussed as part of the 6/1 renewal cycle.

“This project comes from several years of actively listening to the global reinsurance market about offshore energy, as well as the industry’s overall need for more original risk.”

The cat in a box structure is widely used in the Gulf of Mexico energy sector, and ongoing developments by Verisk seeks to expand its adoption in the region, and also other regions where there’s client demand and an ability to do so.

Verisk expands to explain that its working plan is to provide historical oil platform physical value data from Wood Mackenzie “as a starting point for estimating the industry wide loss from a Gulf of Mexico catastrophe event (and other regions, as warranted by client demand).”

The new process that Verisk is working on and welcoming industry feedback on with Wood Mackenzie, seeks to go beyond simply indicating a loss once an event of a specific magnitude has passed through the pre-defined box.

Once a potential loss event has been indicated and there is satisfaction concerning the magnitude/location measures, Wood Mackenzie would then identity platforms within the box that are affected, based on its proprietary database.

Then, utilising historical physical values and existing equipment replacement costs, Wood Mackenzie would look to create an industry-wide loss estimation, which, once completed the result would be published by Verisk to all parties relevant to transactions.

Johansmeyer continued; “Even with significant offshore energy capacity growth over the past decade, there’s still plenty of demand out there waiting to be serviced, particularly in the primary market.

“Addressing that demand creates new opportunities for growth at every link in the risk and capital supply chain. The challenge, of course, is finding a way to write that original business in a way that makes sense for the risk-bearer.”

It’s here, explains Johansmeyer that the refined, or enhanced cat in a box structure could prove useful and valuable to the market, as it offers “a more effective proxy for industry loss, which reduces basis risk and makes the protection more effective.”

Therefore, incorporating Wood Mackenzie data within the traditional cat in a box structure could help to expand the offshore energy market, says Johansmeyer.

“There’s capacity that wants it. There are cedents and original insureds that want cover. The only thing missing has been the trigger, and based on market feedback, it looks like we’ve addressed the industry loss concern – at least until a true loss aggregation platform comes to market,” said Johansmeyer.

As highlighted by Johansmeyer the Gulf of Mexico offshore energy market certainly isn’t short of demand, but limitations with existing products, like the cat in a box structure have limited expansion.

Should an enhanced cat in a box structure come to fruition and reduce the basis risk, it could provide ample opportunity for reinsurers and ILS market participants to deploy capacity into a diversifying peril and region.

This could help to grow the sector and also offer the reinsurance and ILS space with a new avenue to deploy some of the ample capacity that is currently sat in the global reinsurance market, exacerbating the pressures of the softening landscape.

Furthermore, and as highlighted previously, an enhanced cat in a box structure could also be used in other  regions and for underserved risks, which would also create more opportunities for reinsurers and ILS players to deploy capacity.

Perhaps a similar concept could be leveraged, where industry values at risk data is available, to provide a parametric cover, combined with an industry loss type approach, for industrial facilities on the shore at risk of storm surge, or factories at risk of high winds, flooding, earthquake or other catastrophic perils.