12 March 2014 Alternative Risk Transfer

ILS forum debates viability of terrorism bonds

Standard & Poor’s (S&P) is open to rating new risks that could be covered using insurance-linked securities (ILS) but terrorism risk could be a step too far for the rating agency, despite calls from some investors for the ILS market to consider this risk.

Gary Martucci, director of the rating agency’s Financial Service Ratings group, commented on this issue during a panel discussion at the SIFMA Insurance and Risk Linked Securities conference last week.

“We’re not adverse to rating new risks, but a terrorism bond would be very hard to do,” he said. “I’d be scared to have a modelling discussion discussing frequency of the event to start with.”

Martucci’s comments followed John Seo, co-founder and managing principal at Fermat Capital Management’s opinion that in order to facilitate growth, terrorism could be modelled for the bond market with the risk data currently available.

“I’d like to use terrorism as an example,” said Seo. “It’s very complex, but we do have risk models for this and they’re surprisingly developed and advanced for certain high value, high risk type of targets.

“Intelligence agencies report the number of low level, high value attacks and as terrorists aren’t interested in attacking random, invaluable targets, this is where we need to begin.”

He added: “Terrorism risk models are quite developed around these risks, so as an example you could build a cover around those model exposures.”

He explained that the nature of catastrophes is about concentration and suggested that available risk models could isolate 80 percent of truly catastrophic terrorism risk, pinpointed to six main structures in the US.

“If you identified within a single structure the densest commercial and most threatened area and set up a parametric trigger, similar to earthquake, if the attack happened within a six block radius of that structure then there’s a pay-out.

“It doesn’t have to be visual; it can be based on the amount of rubble produced or anything that can measure physical damage. I think you’d be surprised at just how valuable that type of coverage would be to a variety of corporations exposed to business interruption risk or physical damage as a result.”

Seo concluded his thoughts by urging the industry to “stop attacking the model for what it doesn’t have and look at what it does”.

To read the supplement published by Intelligent Insurer at the SIFMA event, please email john.walsh@newtonmedia.co.uk  to obtain a digital version.

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