Cat model reassessments cause rating and capital changes

Last fall’s disastrous hurricanes provided some rough times for the catastrophe modeling industry. Consequently the principal cat modelers — Applied Insurance Research, EQE International’s EQECAT, and Risk Management Solutions — went back to the drawing board to reassess their models of the risks and the consequent potential losses from natural disasters, particularly hurricanes.

These revised models are now becoming available, and practically without exception they contemplate higher loss figures. Speaking at the World Insurance Forum in Bermuda in February, Hemant Shah, RMS CEO, warned that insurers should be preparing to increase their reserves for catastrophe losses, not only due to the unprecedented 2005 hurricane season, but also to prepare for a “stormy future.”

In April RMS said increases to hurricane landfall frequencies in the company’s U.S. hurricane model would increase “modeled annualized insurance losses by 40 percent on average across the Gulf Coast, Florida and the Southeast, and by 25 percent to 30 percent in the Mid-Atlantic and Northeast coastal regions relative to those derived using long-term 1900-2005 historical average hurricane frequencies.” For good measure RMS also upgraded its European Windstorm model in May, as did AIR, which had already updated its Florida hurricane model. This month RMS updated its earthquake models for the Eastern U.S. and Canada.

In April EQECAT’s President Rick Clinton issued a stark warning to insurers, reinsurers, corporations, and government entities, urging them to be prepared for more frequent and severe hurricanes in the Atlantic Ocean, Caribbean Sea, and Gulf of Mexico for the next decade or more. “The current forecast, coming after the industry’s difficult 2004 and 2005 hurricane experience, is putting more pressure on companies to improve their understanding of and to aggressively manage their catastrophe risk,” he observed.

Standard & Poor’s reacted by putting a number of Cat Bonds issued by Swiss Re, PXRE, Hartford, Converium and USAA on its CreditWatch list with negative implications. “The change has been prompted by recent actions taken by catastrophe modeling firms … to update their calculations of expected loss,” S&P said.

The effects are already showing up. Swiss Re, a leading advocate of transferring risk to the capital markets through Cat Bonds, announced a $950 million natural catastrophe protection program named “Successor,” a follow-up vehicle to its “PIONEER” and “Arbor” securitization programs. It covers North Atlantic Hurricanes, Europe windstorms, Californian and Japanese earthquakes.

While S&P rates Swiss Re “AA,” it rated the notes between 6 and 8 notches lower, putting them in the “BB,” “BB-” and “B” range. Even though there has yet to be a reported loss to investors on a Cat Bond, S&P is signaling that the probability that there will be one has significantly increased. The cost to Swiss Re, and other companies, who issue Cat Bonds, has also significantly increased, as more points and higher interest payments are going to have to be made to make the bonds attractive to the institutional investors who buy them.

Topics Catastrophe Hurricane Swiss Re