Tag Archives: insurance-linked securities

The Sum of Its Parts: Wildfire in Multi-Peril Catastrophe Bonds

Water, wind, and wildfire. It’s been a devastating three months for the U.S.

Total insured losses from Hurricanes Florence and Michael, and the Camp and Woolsey wildfires are estimated by RMS in the range US$18.6 billion to US$28 billion (see table below):

September 1 Hurricane Florence $2.8 – $5.0 billion
October 8 Hurricane Michael $6.8 – $10.0 billion
November 8 Camp Wildfire $7.5 – $10.0 billion
November 8 Woolsey Wildfire $1.5 – $3.0 billion
TOTAL INSURED LOSSES   $18.6 – $28 billion

While California wildfires may seem far removed from Atlantic storms, for capital markets investors the fires may make the difference to how 2018 is remembered. Insurance Linked Securities (ILS) eyes are now trained on multi-peril aggregate catastrophe bonds.

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A Toe in the Water: Trading Risk Panel Discusses U.S. Flood Risk Opportunities

With positive changes under way to improve both public and private carrier participation across the U.S. flood market, many are looking to seize the opportunity that the U.S. flood market presents. Insurers, reinsurers, and the capital markets are exploring this opportunity which, in turn, has created a thirst for knowledge. I had the opportunity to see this first-hand when I was invited by Trading Risk magazine to take part in a panel discussion at the Trading Risk ILS: Reloaded and Resurgent event in New York last month. Sofia Geraghty from Trading Risk served as our moderator, and Joanna Syroka, Director of New Markets at Fermat Capital Management, and Ian Hanson, Vice President of Willis Re, were also on the panel.

One point that the audience wanted to understand was the level of demand to take on flood risk from an investor’s viewpoint, and also whether U.S. flood risk can be a portfolio diversifier. From the insurance-linked securities (ILS) side, Joanna confirmed the demand is there, but as with any peril, the ILS market needs to be able to clearly understand and define the risk to get comfortable enough to invest.

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New Opportunities for Investors Willing to Embrace the “Resilience Gap”

This is a reprint of a “Trading Room” interview from Trading Risk magazine, please click here to visit the magazine website.

 

Opportunities abound for investors willing to embrace the resilience gap, according to RMS global managing director Daniel Stander

How does the Protection Gap offer opportunities for investors?

I’m afraid you’ve pushed one of my buttons with your very first question! I’ve been trying (unsuccessfully it seems) to move the debate away from the “protection gap”. I much prefer to talk about the “resilience gap”. This isn’t me being a pedant. The language we use here is important. Framing the problem in terms of “protection” grounds the debate in risk-transfer solutions.

But we all know that risk capital alone cannot address the fact that communities all over the world are frequently brought to their knees by the impacts of extreme events. Risk financing is no silver bullet. Those at risk — from the individual homeowner to the elected official governing a sovereign state — need much more than just contingent capital to materially increase their resilience to acute shocks. They need to develop a deeper understanding of the risks they face — and how it compares to their desired ability to withstand extremes.

More than that, they need to understand what interventions offer an acceptable ROI — from enforcing building codes to preserving nature-based defenses. And then of course they need to be prepared to respond effectively when the ground shakes or the wind blows, lest the economic impacts escalate. Opportunities abound for investors – but they will only be seized by those who can embrace the totality of the “resilience gap” and position their risk capital in the totality of the need.

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The Case of the Trapped Collateral

Was Hurricane Irma in Florida a fire drill for the insurance-linked securities (ILS) and collateralized reinsurance markets — or was this the real thing? In terms of losses, what happened is at the lower end of what the Irma loss in Florida could have become. But what if some of the stuffing had not been knocked out of the storm in Cuba, and if Irma had landed on either the east or west Florida coasts instead of lumbering into the Everglades?

If Irma was a fire drill, then one topic it has highlighted is that faced by “trapped collateral”.

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Clearing the Path for Catastrophe Bond Issuance

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 Metrocat, PennUnion 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

The ILS Community Is Calling Out for Greater Pricing Transparency

I often hear reinsurance underwriters comment on how difficult it is to capture and represent all of the risks underlying a single transaction. Their data comes in many different formats, sometimes from broker or cedants’ own models, which can result in significant differences in modelling assumptions from one transaction to the next. Alongside this, deals almost always include some unmodeled risks like terrorism, aviation or marine. Consolidating all the risks in a transaction into a single view can be frustratingly complex.

This was a tolerable situation in the world of traditional reinsurance, when an underwriter’s autonomy and experience carried greater weight, and capital providers—usually shareholders—were less interested in the finer details of the risks. But the world has changed. Today, as collateralized reinsurance and sidecars financed by highly technical investors become increasingly widespread, especially in retrocession markets, better quality data is more important than ever, and often essential to getting the deal done.

Furthermore, the Insurance Linked Securities (ILS) market demands valuation of its on-risk investments, as fund managers face increasing pressure from stakeholders (internal compliance, regulators, and especially investors) to have deals marked independently.

The challenges

The challenge is compounded by capital markets investors’ broadening appetite for reinsurance risk. Both excess of loss layers and quota share deals are in the frame, with the former often covering tail risk with a low probability of attachment, and the latter the full distribution of risks with a high frequency of loss that’s attritional in nature. Deal pricing is fundamentally dependent on the transaction structure. Attachment and exhaustion probabilities determine the likelihood that event losses will trigger and exhaust a layer, and ultimately how losses within a layer will develop over a risk period. Because of this, a time-dependent view of loss development and ‘incurred but not reported’ claims should influence investment valuations. Historically, this has proved difficult to achieve, given the inconsistent data and unmodeled risks typically supplied in a deal submission. Current market solutions employed by fund managers are mainly based on actuarial methods of valuation which do not capture the full risk profile.

Cash flow is also critical. Net earned premium should be risk weighted to ensure that future premium cash flow is not accrued before the risk has passed. Set-up costs including brokerage fees, taxes, and others should also be considered. Lastly, pricing models must be dynamic, such that the technical price is updated to reflect actual reported losses, and cash flow forecasts are recalibrated accordingly.

Such a view of risk and return – one which is both time and structure-dependent – is fundamental to arriving at the proper valuation of a reinsurance deal in isolation and, also critically, for a portfolio. A uniform procedure for transaction and outstanding deal pricing is therefore crucial to satisfying investors and their stakeholders.

We can now achieve all of that easily, regardless of the state of the risk information in hand.

RMS’ Miu platform offers a single environment in which to analyse all risks within a transaction, with a new multi-model risk aggregation feature complimented by a pricing service. The simulation-based tool delivers a single, holistic view of the risk in a proposed or live transaction and provides complete portfolio roll-up capabilities. In addition, the RMS mark-to-model pricing service provides weekly marks to support net present value calculations for deals, portfolios, and fund of fund strategies.

The solution

By using the RMS Miu platform, investors and reinsurers can import loss data in multiple formats, including exceedance probability (EP) curves, results data modules (RDMs), and event loss tables (ELTs), and fold them into a single, comprehensive view of risk. It’s an easy process which can be done while maintaining correlations between peril regions, whether the risk is modeled by RMS or not, capturing correlation of non-modeled risks across deals by defining a baseline view of risk for specific peril regions.

The Miu applications enable investors and reinsurers to unify their universe of risk into one place. More broadly, the platform facilitates their ability to model and share ILS reinsurance transactions by providing a single view of risk, in so doing delivering the market transparency that leads to improved pricing certainty, and consequently more capital for the sector.

This post was co-authored by Anaïs Katz and Jinal Shah. 

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.

RMS and the FIFA World Cup: Insuring Against Terrorism

As we reflect back on this year’s World Cup, which wrapped up without interruption after Germany’s victory on Sunday, it is clear that FIFA’s financial position is much stronger now than in 2006, due in part to the availability of terrorism insurance.

Eleven years ago, the global elite of the soccer world learned about innovative RMS risk analysis to help FIFA to prepare for the 2006 World Cup in Germany. Sponsorship money was essential for FIFA’s cash flow and sponsors insisted on having insurance coverage against event cancellation. After 9/11, terrorism insurance became a necessity, but was available only through Warren Buffet, the astute insurer of last resort, and was extremely expensive. So, FIFA pursued alternative risk transfer to the capital markets through a catastrophe bond.

FIFA’s bankers at Credit Suisse turned to RMS to do what had been thought impossible – to get a terrorism risk securitization rated. It took multiple RMS meetings with Moody’s in London and New York over the course of a year to present and discuss the unique terrorism risk analysis and eventually secure an investment grade rating for Golden Goal Finance Ltd. This $260 million deal remains to this day the only stand-alone securitization of terrorism risk. Prospects for further terrorism risk securitizations depend on the scope of the U.S. Terrorism Risk Insurance Act, which will be renewed at the end of 2014 with some further incremental reduction in the role of the federal government, but RMS was instrumental in instituting the precursors to these prospects.

Securitization of the cancellation risk of the 2006 World Cup was feasible in part due to the national importance of the event, which received extensive counter-terrorism protection.

While cancellation was still the biggest risk this year, the predominant local threat to the World Cup was disruption by public protest and riot. Following the start of the Arab Spring in 2011, there has been a surge of demand for international riot insurance, with a commensurate interest in riot analysis. As with terrorism, security is particularly crucial for the control of riot risk. With 170,000 Brazilian security personnel on duty for the month of the soccer tournament, insurers were able to enjoy the matches without concern that the July 13 final in Rio would be delayed.

While terrorism insurance is more widely available than in the past, it is still in short supply. Expanding modeling capabilities and increased demand for products such as terrorism and riot insurance will result in more insurance-linked securities (ILS) transactions such as the 2006 catastrophe bond, and ultimately promote a more resilient society.

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.