Category Archives: Capital Markets

Exceedance 2015: In the Books

It’s been quite a week here in Miami – full of palm trees, ocean views…and catastrophe risk management.

Throughout the week, our keynote speakers discussed hot topics in science, catastrophe modeling, and risk management:

  • We kicked off the week with keynotes from Hemant Shah, Paul Wilson, Ben Brookes, and Daniel Stander discussing RMS’ vision for the future and how catastrophe modeling can enable innovation and growth within the (re)insurance industry and beyond.
  • Patricia Grossi shed light on earthquake risk in Latin America, and there were more than a few misty eyes as Laurence Golborne regaled us with tales of risk management from his time as minister of mines and energy in Chile, where he led the rescue of the “Los 33” miners trapped underground for more than two months.
  • Rick Knabb, director of the National Hurricane Center, explained why awareness is central to the mission of the NHC; educating the public about the need to prepare increases the ability to recover.
  • Robert Muir-Wood explained that the biggest concentrations of risk and gradients of risk are coastal, necessitating state-of-the-art modeling of storm surge, tsunami, and liquefaction in order to mitigate this risk.

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Hemant and other members of the RMS leadership team answered questions on-stage during an “Ask Us Anything” session. Here are a few highlights:

  • What’s your vision beyond 2020?
    • Eric Yau: We want to create an open platform that unlocks innovation potential for our clients and partners.
    • Matthew Grant: Our goal is to allow clients to underwrite business that isn’t possible today. We will work together to grow the broader (re)insurance market.
  • What can I do to help Nepal? 
    • Paul VanderMarck: We work with Build Change, an organization aligned with our mission of mitigating risk. We recommend them as an organization and are matching employee contributions. Build Change is starting a program in Nepal using the same playbook that has already been successful in areas such as Haiti and Japan.
  • Suppose you were to start from scratch today – would you do anything differently? 
    • Mohsen Rahnama: When we started, we didn’t have any of the tools we have today. We take advantage of and implement technology to approach problems in a systematic way. Technology allows us to build better models.

In addition, we were thankful to have many of our clients and partners not just attend, but present at Exceedance. BMS, JLT RE, Munich Re, Aon Benfield, Risk Frontiers, Holborn Corp, ARA, Willis Re, Guy Carpenter, TigerRisk, SCOR, and Price Forbes all presented during the “Alternative Views of the Market” track which provided insight from across the industry.

  • Munich Re showed impactful videos of homes under 100 mph winds, emphasizing the difference in performance of structures built to various standards.
  • Willis Re advocated for deterministic modeling and developing alternative views of risk by considering different sizes of events and “what if” analyses.
  • Guy Carpenter explained how to define critical events by aligning the level of loss to specific outcomes such as lost earnings, ratings watches, and ratings downgrades.

And finally, we salsa-ed the night away to the sweet tunes of two-time Grammy-nominated Latin band Palo during EP, the Exceedance Party, at LIV nightclub.

I hope you enjoyed the week and found it insightful and thought-provoking. We hope to see you all back at the Fontainebleau Miami Beach Hotel next year, where Exceedance 2016 will take place from May 16 to 19.

Risk, Models, and Innovations: It’s All Interconnected

A few themes came through loud and clear during this morning’s keynote sessions at Exceedance 2015.

RMS’ commitment to modeling innovation was unmistakable. As RMS co-founder and CEO Hemant Shah highlighted on stage, RMS worked hard and met our commitment to release RiskLink version 15 on March 31, taking extra measures to ensure the quality of the product.

Over the past five years, RMS has released 210 model upgrades and 35 new models. With a 30% increase in model development resources over the last two years and 10 HD models in various stages of research and development, RMS has the most robust model pipeline in its history.

As Paul Wilson explained, HD models are all about providing better clarity into the risk. They are a more precise representation of the way a physical damage results in a (re)insurance loss, with a more precise treatment of propagation of uncertainty through the model, designed to deal with losses as closely as possible as the way claims occur in real life.

HD models are the cornerstone of the work RMS is doing in model development right now. HD models represent the intersection of RMS research, science and technology. With HD models we are not limited by software – we can approach the challenge of modeling risk in exciting new ways.

And it’s more than just the models – RMS is committed to transparency, engagement, and collaboration.

RMS’ commitment to RMS(one) was also clear. Learning from the lessons of the past year, RMS developing an open platform that’s not just about enabling RMS to build its own models. It’s an exposure and risk management platform that’s about enabling clients and partners to build models. It’s about analytics, dynamic risk management and more.

RMS(one) will be released, judiciously and fully-matured, in stages over the next 15 months,starting with a model evaluation environment for our first HD Model, Europe Flood, in autumn 2015.

And, Hemant emphasized that starting later this calendar year, RMS will open the platform to its clients and partners with the Platform Development Kit (PDK).

In addition, RMS(one) pricing will be built around three core principles:

  • Simple, predictable packages
  • In most cases, no additional fees for clients who simply want continuity in their RMS modeling relationships
  • Clearly differentiated high-value packages at compelling prices for those who wish to benefit from RMS(one) beyond its replacement as a superior modeling utility to RiskLink

The overall goal of RMS’ commitment to modeling and technology innovation is to capitalize on a growing and ever-changing global (re)insurance market, ultimately building a more resilient global society. RMS is working with industry clients and partners to do so by understanding emerging risks, identifying new opportunities to insure more risk, developing new risk transfer products, and creating new ways of measuring risk.

As Ben Brookes said, we only have to look at the recent events in Nepal to understand that there are huge opportunities – and needs – to improve resilience and the management of risk. RMS’ work for Metrocat, a catastrophe bond designed specifically to protect the New York MTA’s infrastructure against storm surge, showed the huge potential for the developing alternate methods of risk transfer in order to improve resilience.

And during his session, Daniel Stander pointed out that only 1.9% of the global economy is insured. As the world’s means of production shifts from assets to systems, RMS is working to understand how to understand systems of risk, starting with marine, supply chain, and cyber risk, tackling tough questions such as:

  • What are the choke points in the global shipping network, and how do they respond under stress?
  • How various events create a ripple effect that impact the global supply chain – for example, why did the Tohoku earthquake and tsunami in Japan cause a shortage of iPads in Australia, halt production at BMW in Germany, and enable a booming manufacturing industry in Guangzhou?
  • How do we measure cyber risk when technology has become so critical that it is systemically important to the global economy?

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Leaving the keynotes, a clear theme rang true: as the world becomes more interconnected, it is the intersection of innovation in science and technology that will enable us to scale and solve global problems head on.

The 2015 U.K. Budget and Terrorism Insurance

On 18 March, the Chancellor of the Exchequer, George Osborne, delivered his pre-election budget. Billions of further public spending cuts are needed. Several weeks earlier, Pool Re, the U.K. terrorism insurance pool, announced its first ever purchase of reinsurance in the commercial market.

These two announcements are not unconnected.

Pool Re was set up in 1993, after the IRA bombing of the Baltic Exchange in 1992. Since the pool was established, it has built up quite a substantial surplus; claims have been low thanks to the vigilance of the security and intelligence services. Almost all the major plots since the September 11, 2001 attack have been foiled.

Terrorism insurance is effectively insurance against counter-terrorism failure, and the huge sums spent on blanket indiscriminate surveillance have helped to minimize terrorism insurance losses. The low level of losses is not coincidental, or due to some unpredictable whim of terrorist behavior but readily explainable; too many terrorists spoil the plot. The type of plots capable of causing terrorism insurance losses of a billion pounds or more would involve a sizeable number of operatives.

As the NSA whistleblower Edward Snowden has revealed, the level of surveillance of electronic communications is so intensive that sizeable terrorist social networks end up being tracked by NSA and GCHQ. Lesser plots involving lone wolves or several operatives are most likely to be successful. A string of these have struck the western alliance over the past months in Ottawa, Sydney, Paris, and Copenhagen. Besides causing terror, these have attracted global media publicity, inspiring Jihadi recruitment. But terrorism insurance covers property loss, not the spread of fear or growth in the ranks of Islamic State.

Having developed a tough security environment, it is unsurprising that the U.K. Government should be questioning its continuing exposure to terrorism insurance risk. This is an age of austerity. Pool Re’s three year program provides £1.8bn of reinsurance cover, so diminishing this exposure. More cover might have been purchased, but this was the market limit, given that Chemical-Biological-Radiological-Nuclear (CBRN) risks were included.

The idea of separating out extreme CBRN terrorism risks was considered in Washington by the House Financial Services Committee in the discussions last year over the renewal of the Terrorism Risk Insurance Act. The objective was to provide a federal safety net for such extreme risks, whilst encouraging further private sector solutions for conventional terrorist attacks. This idea was considered at some length, but was a step too far for this TRIA renewal. It might be a step for Pool Re.

The modus operandi of the IRA was to avoid killing civilians. This would alienate their Catholic community support. Bomb warnings, genuine and hoax, were often given. Thus the metric of IRA attacks was typically physical destruction and economic loss. Islamist militants of all persuasions have no such qualms about killing civilians. Indeed, gruesome killings are celebrated. Terrorists follow the path of least resistance in their actions. For Islamic State, this is the path of brutal murder rather than property damage.

Rising Storm Surge Losses in the U.S. Northeast

Co-authored by Anaïs Katz and Oliver Withers, analysts, Capital Market Solutions, RMS

A recent article in Nature Communications, picked up by the BBC, identified a record mean sea-level rise of 5” (127mm) along the coastline north of New York City during 2009-10. Sea levels fluctuate between years; a swing of this size, however, was unprecedented.

This extreme rise in 2009-2010 has been attributed to the downturn of a major current called the Atlantic meridional overturning circulation (AMOC). As changes to sea levels are sensitive to multiple factors, there is volatility around this increase. The AMOC is one of the ocean’s dynamics that is known to have greatly changed over time. It has been shown that weakening and variation of the AMOC is linked to increases of greenhouse gas emissions.

Sea level rise is one of the most tangible and certain consequences of a warmer climate. Climate models suggest that even if greenhouse gas emissions were reduced sea levels will continue to increase. Such a dramatic fluctuation, as seen in 2009-10, highlights the potential for significantly elevated storm surge risk in the region and raises the question what will the impact of future long-term sea-level rise have on storm risk.

A study by Kopp et al. has attempted to predict probability bands for sea rise. The figure below shows the distribution of expected sea-level rise at New York City’s Battery Park throughout the 21st century. The 50th percentile projection of sea level rise is represented as the red line in the figure. Also shown are the maximum rises in sea levels associated with previous hurricane storm surges.

Based on RMS’ estimate of the impacts from hurricanes on residential and commercial property in the Northeast US (from New Jersey north), the 2010 estimate of storm surge contribution to hurricane losses is about 10%. Even where the activity of hurricanes does not change, sea level rise will increase the damage associated with hurricane storm surges. Based on Kopp’s estimates of sea level rise, by 2100 surge losses would contribute about 25% of total hurricane losses.

The largest recent hurricane loss occurred on October 29th 2012, when Superstorm Sandy made landfall near Atlantic City, NJ. Based on the RMS best loss estimate, Sandy caused insured losses between $20 and $25 billion, with much of the damage due to storm surge, not wind.

In terms of a simple extreme value analysis, the storm surge caused by Superstorm Sandy combined with the tide at New York City’s Battery Park was approximately a 1-in-450 year return period for that location. Based on sea level rise alone, this surge and tide combination at this location would move closer to a 1-in-100 year event by the end of the century. The figure below shows the return periods for a storm surge as high as Sandy’s occurring at New York City’s Battery Park, under different sea-level assumptions.

A direct result of increasing amounts of greenhouse gases in the atmosphere will be an increase in sea surface temperatures. While increased sea surface temperatures are likely to cause changes to the activities and intensities of hurricanes, there is no consensus among climate modelers as to the magnitude and direction of these changes. For this reason, the figure below does not consider potential changes in hurricane activity, but focuses solely on sea-level rise, for which there is much more of a general agreement.

While the impacts of climate change remain much debated, changes in loss potential will have material effects on the risk to insurers. With the appreciation of the significance of climate change coming to the fore, the next decades will pose a research challenge for the insurance industry, as to how to incorporate evidence for changes in the level of risk.

This post was co-authored by Anaïs Katz and Oliver Withers. 

Anaïs Katz

Analyst, Capital Market Solutions, RMS
As a member of the advisory team within capital market solutions, Anaïs works on producing capital markets’ deal commentary and expert risk analysis. Based in Hoboken, she provides transaction characterizations to clients for bonds across the market and supports the deal team in modeling transactions. She has woked on notable deals for clients such as Tradewynd Re and Golden State Re. Anaïs has also helped to model and develop her group’s internal collateralized insurance pricing model that provides mark to market prices for private transactions. Anaïs holds a BA in physics from New York University and an MSc in Theoretical Systems Biology and Bioinformatics from Imperial College London.

Fighting Emerging Pandemics With Catastrophe Bonds

By Dr. Gordon Woo, catastrophe risk expert

When a fire breaks out in a city, there needs to be a prompt firefighting response to contain the fire and prevent it from spreading. The outbreak of a major fire is the wrong time to hold discussions on the pay of firefighters, to raise money for the fire service, or to consider fire insurance. It is too late.

Like fire, infectious disease spreads at an exponential rate. On March 21, 2014, an outbreak of Ebola was confirmed in Guinea. In April, it would have cost a modest sum of $5 million to control the disease, according to the World Health Organization (WHO). In July, the cost of control had reached $100 million; by October, it had ballooned to $1 billion. Ebola acts both as a serial killer and loan shark. If money is not made available rapidly to deal with an outbreak, many more will suffer and die, and yet more money will be extorted from reluctant donors.

Photo credits: Flickr/©afreecom/Idrissa Soumaré

An Australian nurse, Brett Adamson, working for Médecins Sans Frontières (MSF), summed up the frustration of medical aid workers in West Africa, “Seeing the continued failure of the world to respond fast enough to the current situation I can only assume I will see worse. And this I truly dread”

One of the greatest financial investments that can be made is for the control of emerging pandemic disease. The return can be enormous: one dollar spent early can save twenty dollars or more later. Yet the Ebola crisis of 2014 was marked by unseemly haggling by governments over the failure of others to contribute their fair share to the Ebola effort. The World Bank has learned the crucial risk management lesson: finance needs to be put in place now for a future emerging pandemic.

At the World Economic Forum held in Davos between January 21-24, 2015, the World Bank president, Jim Yong Kim, himself a physician, outlined a plan to create a global fund that would issue bonds to finance important pandemic-fighting measures, such as training healthcare workers in advance. The involvement of the private sector is a key element in this strategy. Capital markets can force governments and NGOs to be more effective in pandemic preparedness. Already, RMS has had discussions with the START network of NGOs over the issuance of emerging pandemic bonds to fund preparedness. One of their brave volunteers, Pauline Cafferkey, has just recovered from contracting Ebola in Sierra Leone.

The market potential for pandemic bonds is considerable; there is a large volume of socially responsible capital to be invested in these bonds, as well as many companies wishing to hedge pandemic risks.

RMS has unique experience is this area. Our LifeRisks models are the only stochastic excess mortality models to have been used in a 144A transaction, and we have undertaken the risk analyses for all 144A excess mortality capital markets transactions issued since the 2009 (swine) flu pandemic.

Excess mortality (XSM) bonds modeled by RMS  
Vita Capital IV Ltd 2010
Kortis Capital Ltd 2010
Vita Capital IV Ltd. (Series V and VI) 2011
Vita Capital V 2012
Mythen Re Ltd. (Series 2012-2)XSM modeled by RMS 2012
Atlas IX Capital Limited (Series 2013-1) 2013

With this unique experience, RMS is best placed to undertake the risk analysis for this new developing market, which some insiders believe has the potential to grow bigger than the natural catastrophe bond market.

Using Network Theory to Understand the Interconnectivity of Financial Risk

For today’s regulators, systemic risk remains a major issue. Tracing the connections between financial institutions and understanding how different mechanisms of financial contagion might flow through the system is complex.

Modern finance is a collective of the activities of tens of thousands of individual enterprises, all interacting in a “living” system. Today, nobody truly understands this system. It is organic and market-driven, but the fundamental processes that drive it occasionally collapse in a financial crisis that affects us all.

The increasing risk of financial contagion in the financial industry has triggered a new discipline of research – called “network theory in financial risk management” – which is quickly gathering pace. These valuable studies aim to identify and analyze all possible connections between financial institutions, as well as how their interconnectivity can contribute to crisis propagation.

Later this month, Risk.net will launch the Journal of Network Theory in Finance. This journal will compile the key papers of financial risk studies worldwide to provide industry participants with a balanced view of how network theory in finance can be applied to business.

Papers from the inaugural edition of the new journal will be showcased on September 23 at the Financial Risk & Network Theory conference, which is hosted by the Centre for Risk Studies at the University of Cambridge. I will be presenting a keynote on how catastrophe modeling methodologies can be applied to model financial risk contagion.

Our financial institutions are connected in a multitude of ways. For example, by holding similar portfolios of investments, using common settlement mechanisms, owning shares in each other’s companies, and through inter-bank lending.

As the interconnectivity of the world’s financial institutions and markets deepens, financial risk managers and macro-economic planners need to know the likelihood and severity of potential future downturns, particularly the “tail” events of economic catastrophe. Companies must continually understand how they are exposed to the risk of contagion; many were surprised by how fast contagion spread through the financial system during the 2008 credit crunch.

The regulator’s role in limiting the risk of future financial crises includes identifying Systemically Important Financial Institutions (SIFIs) and understanding what aspects of a SIFI’s business to monitor. Regulators have already pioneered network modelling to identify the core banks and to rank their systemic importance, and can now demand much higher standards of risk management from the SIFIs. Increasingly, similar models are being used by risk practitioners and investment managers.

The studies of network theory in financial risk management, such as those carried out by the Centre of Risk Studies, provide valuable insight for all risk practitioners involved in managing financial risk by providing a robust foundation of science from which to understand, model and, ultimately, manage financial risk effectively.

Trading Risk Awards: ILS Innovation Recognized

In June, RMS had the pleasure of hosting a table at the Trading Risk Awards in London. These annual awards aim to recognize the best of the (re)insurance convergence market: individuals and companies contributing to the advancement of the insurance-linked securities (ILS) industry.

That night three RMS-modeled transactions that came to market in 2013 were given special recognition: Tradewynd Series 2013-2, MetroCat Re Ltd., and Atlas IX Capital Ltd. These three transactions incorporate several noteworthy innovations that promise to shape the future of ILS.

Initiative of the year – A Multi-Model Approach to Catastrophe Bond Risk Analysis

AIG and Swiss Re Capital Markets were awarded “Initiative of the Year” for their multi-model approach to Tradewynd Series 2013-2. This transaction provided a first for the industry by introducing transparency to a typically opaque and restricted risk management process.

Typically, data is only privy to the modeling firm retained to produce the risk analysis included in the offering documentation. On this occasion, while RMS was the main modeling agent for the deal, AIG’s exposure data was supplied to all three modeling firms so that investors had a more accurate representation of the risk of the bond under multiple views.

Not only did investors get the RMS view of commercial and high-end residential risk on this bond, they also got unprecedented insights into the exposures driving the risk. The market reacted favorably to the approach with markedly tighter spreads and larger issuance than the prior Tradewynd bond with a nearly identical risk profile.

Non-Life Transaction of the Year – MetroCat Re Ltd

This groundbreaking surge-parametric transaction received two accolades: the Metropolitan Transportation Authority (MTA) was awarded “Sponsor of the Year,” and the deal itself was proclaimed “Non-Life Transaction of the Year,” recognizing the MTA, GC Securities, and Goldman Sachs for their roles in the transaction.

The MetroCat bond addressed the need for surge-insurance capacity after Superstorm Sandy by providing the MTA with insurance cover based on water levels exceeding certain heights at tide gauges in the New York area. The RMS® North Atlantic Hurricane Model, with its full-lifecycle hydrodynamic modeling capability, was critical in understanding the risk to the transaction. The success of MetroCat Re proves that corporates and municipalities can access capital through ILS, as well as produce transactions that provide much needed surge cover.

Life Transaction of the Year – Atlas IX Capital Ltd.

Aon Benfield Securities, BNP Paribas, Natixis, and SCOR won “Life Transaction of the Year” for Atlas IX Capital Ltd., the highest risk bond of its kind to come to market. For this watershed deal, RMS used its suite of LifeRisks models to provide scenario-based modeling results. This allowed investors to gain greater insight into the risk to the transaction from changing trends in baseline mortality in addition to excess mortality from infectious disease, terrorism, earthquakes, and residual risks.

Congratulations to all the winners. We are delighted to see continued innovation in the market.

Modeling the Deal of the Year

The first storm surge catastrophe bond ever released in the insurance-linked securities markets was awarded “Deal of the Year” by Bond Buyer and the Insurance Risk Awards. What what is that made this bond, issued for New York’s Metropolitan Transit Authority (MTA) so special?

Sandy may not have been the strongest tropical storm to make landfall in the United States, but its insured losses of $20-25 billion rank it as one of the most costly. And like Katrina, most of the losses were not driven by high winds, but by coastal flooding from extreme storm surge.

The MTA was badly hit, with roughly $5 billion in flood damages. Alongside high industry losses, the traditional reinsurance market hardened, so to obtain funding the MTA turned to alternative sources through MetroCat Re Ltd., a parametric catastrophe bond modeled by RMS Capital Markets.

A parametric bond is different from a traditional reinsurance agreement in that it is triggered when a hazard value—in this case water level—reaches a specific threshold, as opposed to to a financial threshold trigger.

Although seldom seen in traditional reinsurance, parametric triggers are more frequently used in alternative capital. There’s no need to study detailed exposure and claims information before or after the event and payment can be made in weeks, not years.

How did RMS help?

Before Sandy, simple storm surge models based on storm parameters—such as angle of landfall, forward speed, and central pressure—were considered sufficient to model storm surge risk. Sandy, however, showed that it is important to understand the full lifecycle of a storm. Sandy wasn’t even a hurricane at landfall, therefore the parameters in simple storm surge models would have predicted a far smaller surge and missed a lot of the potential damage.

RMS provided a detailed understanding of the surge risk to MTA’s assets using the RMS version 13.0 North Atlantic hurricane model, which incorporates a state-of-the-art, hydrodynamic storm surge model to capture the impacts of local tide interactions, seafloor, and coastline on the size of the storm surge.

The modeling results were highly successful, with the surge across the region matching closely the observed surge:

Comparison of a) FEMA and  b) RMS surge extents for Sandy around Battery Park, NY

Comparison of a) FEMA and b) RMS surge extents for Sandy around Battery Park, NY

Verification: RMS’ Sandy footprint against observed water heights

Verification: RMS’ Sandy footprint against observed water heights

New York’s complicated coastline needed to be modeled in detail to accurately understand how the surge would develop—for example, around the Robert F Kennedy Bridge, the water shallows, leading to relatively uncorrelated areas that separate New York harbor from the Long Island sound. This correlation needed to be considered when we were constructing the parametric trigger for MetroCat – only triggering from one location wasn’t enough, therefore we based the index on both New York harbor and Long Island water levels.

We estimate a 20% chance that for a hurricane in the U.S. Gulf States, coastal flooding will dominate the losses. In the northeast U.S., the risk rises to 30%. MetroCat’s success showed that the ILS market can be a viable risk transfer mechanism for coastal storm surge flooding, if it is supported by detailed, holistic modeling of this complicated peril.