logo image

Cat bond efficiency has come a long way in the last decade. The premature grey hair and portly reflection that peers back at me in the mirror serves as a reminder of a time when even the simplest deals seemed to take months of work.  A whole thriving food delivery industry grew up in the City of London just to keep us fed and watered back when success was measured on capacity to work a 120-hour week, as much as on quantitative ability.

Much has changed since then. Of course, complex ground-breaking deals still take a monumental amount of effort to place successfully—just ask anyone who’s been involved with MetrocatPennUnion or Bosphorus, and they’ll tell you it’s a very intensive process.

But there’s little doubt that deal issuance has streamlined remarkably. It is now feasible to get a simple deal done in a matter of a few short weeks, and the market knows what to expect in the way of portfolio disclosure and risk analysis information. Indeed, collateralized reinsurance trades have pushed things further, removing some of the more complex structural obstacles to get risk into insurance linked securities (ILS) portfolios efficiently.

This week, I was on a panel at the Securities Industry and Financial Markets Association (SIFMA) Insurance and Risk Linked Securities Conference, discussing the ways in which the efficiency of the cat bond risk analysis could be further streamlined. This topic comes up a lot—a risk analysis can be one of the largest costs associated with a transaction (behind the structuring fees!), and certainly a major component of the time and effort involved.

If there’s one aspect we can all agree on, I suspect it’s the importance of understanding the risk in a deal, and how that deal might behave in different catastrophic scenarios. Commoditizing the risk analysis into a cookie-cutter view of a few well-known metrics is not the way to go—every portfolio is unique, and requires detailed, bespoke understanding if you’re to include it in a well performing ILS portfolio.

Going further, it is often suggested that the risk analysis could be removed from cat bonds—indeed, there’s no other asset class out there where the deal documents themselves contain an expertized risk analysis. Investors are increasingly sophisticated—many can now consume reinsurance submissions and have the infrastructure to analyze these in-house. The argument goes, why not let the investors do the risk analysis, and take it out of the deal—that way the deal can be issued more efficiently. One deal—Compass re II—has tested this hypothesis via the Rewire platform, and successfully placed with a tight spread.

Compass was parametric—this meant that disclosure was complete. The index was fully described, so investors (or their chosen modeling consultancy) could easily generate a view of risk for the deal.  This would not have been so straightforward for an indemnity deal—here, as an investor, you’d probably want to know the detailed contents of the portfolio in order to run catastrophe models appropriately. Aggregates won’t cut it if you don’t have a risk analysis.  So, for this to work with indemnity deals, disclosure would have to increase significantly.

An indemnity deal with no risk analysis would also open up the question of interpretation—even if all the detailed data were to be shared, how should the inuring reinsurance structures be interpreted?

This can be one of the most time consuming elements of even the simplest indemnity deals.  Passing this task on to the market rather than providing the risk analysis in the deal would inevitably lead to a change in the dynamic of deal marketing—suddenly investors would be competing more and more on the speed of their internal quoting process, and be required to develop large modeling infrastructure, far larger than most ILS funds currently have access to today.  Inevitably this would take longer and lead to a more uncertain marketing process.  Inevitably it must load cost into the system, which might well be passed back to issuers by way of spread or to end investors by way of management fees. Or both. Suddenly the cost saving in the bond structure doesn’t look as attractive.

I believe there’s a better alternative—and it’s already starting to happen. Increasingly, we are being engaged by potential deal sponsors much earlier in their planning process, often before they’ve even contemplated potential cat bond structures in detail. In this paradigm, the risk analysis can be largely done and dusted before the bond issuance process begins—of course, it’s fine-tuned throughout the discussions relating to bond structures, layers and triggers etc. But the bulk of the work is done, and the deal can happen efficiently, knowing precisely how the underlying risk will look as the deal comes together. This leads to much more effective bond execution, but doesn’t open up the many challenges associated with risk analysis removal.

Detailed understanding of risk, delivered in the bond documentation, but with analysis performed ahead of the deal timeline. Perhaps the catastrophe bond analysts of the future won’t have to suffer the ignominy of receiving Grecian 2000 for their 30th birthdays.

Ben and the RMS capital markets team will be talking more about innovation in the ILS market at Exceedance 2016– sign up today to join us in Miami

You May Also Like
River channel
September 08, 2021
Taking the Guesswork out of Climate Change Metrics
July 15, 2019
Spread the Word on Building Resilience for Vulnerable Communities

It was off to another prestigious London venue last week for the RMS team, to attend the Insurance Post British Insurance Awards at the Royal Albert Hall. In addition to fulfilling lifelong dreams to see Rick Astley perform live, the RMS team was also competing for the Risk and Resilience Award, alongside four other very worthy contenders. And, first presentation of the night, I was delighted to represent RMS to collect this important award. This award recognized our longstanding charity partner Build Change, who we have worked together with for six years. Both organizations share a mission: to reduce lives lost from disasters by strengthening the built environment in economically deprived areas. By combining RMS’ risk modeling expertise and institutional support with Build Change’s technical knowledge and grassroots approach, we’ve been able to demonstrate that retrofitting buildings, from homes to schools, in vulnerable neighborhoods across the globe can significantly reduce economic loss and save lives. And one of our many collaborations was an initiative to greatly improve the safety of seismically-vulnerable communities in Colombia. Ben Brookes, managing director – capital and resilience solutions at RMS, collects the British Insurance Awards 2019 Risk and Resilience Award from FM Global’s managing director Philip JohnsonOver the past 20 years, more than 10 million people have moved to major cities in Colombia such as Bogotá and Medellin. A lack of affordable housing has led many of these low-income families to settle on the outskirts, often building haphazardly with poor quality construction material. According to CENAC (Centro de Estudios de la Construcción y el Desarrollo Urbano y Regional), three out of every five new homes built in Colombia today are of “informal origin”, meaning they are built without any legal procedures or formal design process. City governments are aware of the issue but often lack the means to effectively deal with the increasing vulnerability of their existing housing stock; and these low-income families remain significantly at risk of death, injury and economic loss due to house damage or collapse in a future earthquake. Since late 2013, RMS has been working closely with Build Change, sharing research and expertise and providing early sponsorship of their preventive program activities in Latin America – before a seismic event occurs. This work is focused on promoting the benefits of retrofitting homes for low-income families living in informal neighborhoods in Bogotá, and ranges from working with stakeholders to affect long-term policy changes, developing local skill bases, and stimulating insurance and financing options for low-income households. This approach of using catastrophe models to understand the benefits of potential resilience investments is an increasingly important tool to establish the ‘Resilience Dividend’ for a given investment: Understanding the future risk reduction benefits of various options, in order to get the best ‘bang for your buck’ when deciding how to invest for best resilience outcomes. “This approach of using catastrophe models to understand the benefits of potential resilience investments is an increasingly important tool to establish the ‘Resilience Dividend’ for a given investment: Understanding the future risk reduction benefits of various options, in order to get the best “bang for your buck” when deciding how to invest for best resilience outcomes.” This particular example in Colombia involved the use of RMS earthquake risk modeling, to not only help quantify the potential risks, but to also evaluate how risk levels might change if mitigating factors are put in place. The direct effects of the retrofitting conducted by Build Change were modeled by RMS in terms of costs, cost savings, reduction of losses and reduction of injury and deaths. The study was based on Build Change retrofit methodologies and existing government subsidy systems RMS was able to assess the potential impact and cost effectiveness of a scaled retrofit program which has provided vital insight and has contributed to a wider acceptance of retrofitting in Colombia – and an increased institutional urgency to deal with the problem. We showed that over 120,000 deaths and US$2.8 billion of loss could be avoided in a 1 in 200-year event by retrofitting homes in four neighborhoods studied over a ten-year period. RMS and Build Change also demonstrated that retrofits can be completed with a minimal amount of engineering training, using existing local skills, and for less than half the price of demolishing and rebuilding. One-story retrofits following Build Change’s methodology in Bogotá were completed with an average materials and labor cost of approximately 17 million Colombian Pesos (US$5,825). The materials and labor cost of building a new house of the same size is estimated to be over 54 million Colombian Pesos (US$18,517). Colombia also has a significant bureaucracy that can hamper efforts to improve existing housing stock. For example, city officials in some neighborhoods require over six months to approve of a single house retrofit. This work, consisting of risk modeling advocacy and support for pilot retrofits, has greatly contributed to the Government of Colombia’s recent decision to make the retrofitting of 600,000 homes an immediate national priority. Only through working together has this been achieved. Dr. Elizabeth Hausler, Build Change CEO and Founder, said in our award application, “As a collaborator, RMS truly understands the big picture, knows lives are at stake, and has repeatedly shown a commitment to creating systems change at scale. The mutual enthusiasm shared between RMS and Build Change has resulted in interaction from the board level down, that is not only positively impacting the bottom-line but saving lives.” And likewise, without Build Change’s on-the-ground expertise, and their practical application of technical and scientific approaches, implementation would not have scaled so dramatically. On behalf of RMS and Build Change, I would like to thank the award judges for selecting our entry, and I invite you to find out more about our joint work and also support Build Change to expand the scope of their operations, to help more vulnerable communities gain strength.…

Ben Brookes
Ben Brookes
VP, Consulting Services, RMS

As head of the RMS Consulting Services team, Ben overseas the services work that helps customers maximize the benefits available from working with RMS models, data and applications. He leads a multi-disciplinary services team, comprising nearly 50 individuals with a combined market experience of more than 200 years.  

Ben's leadership role covers all areas of the market, from implementation and technical consulting to on-board and deploy RMS solutions, to process and workflow engagements that help drive the significant business benefits that flow from a robust view of risk, and through to the quantification of risk to support risk transfer, including innovative forms of risk packaging. 

During his 16 years with RMS, Ben has led numerous services teams, as well as business development for the establishment of best practices in new markets for RMS, such as public sector and broad financial services. Ben is closely involved in the significant investments RMS is currently making in climate change. Ben holds an MEng in engineering mathematics from the University of Bristol.

cta image

Need Help Managing Your Portfolio?

close button
Overlay Image
Video Title

Thank You

You’ll be contacted by an Moody's RMS specialist shortly.