“ Catastrophe models have changed many times since S&P began rating cat bonds in 1997, but this appears to be the first time that a large-scale rating action has taken place because of model changes.”


perception of the risk for such peril, we may change the rating on any outstanding bonds even if there is no model-based reset in the terms of any of the bonds concerned.”


As reinsurance practitioners know, vendor catastrophe models change


on a regular, periodic basis as science improves and insurance exposure data change, among other reasons. Catastrophe models for countries and perils have changed many times since S&P began rating cat bonds in 1997, but this appears to be the first time that a large-scale rating action has taken place because of model changes.


If S&P or other rating agencies intend to review and revise bond ratings


when models change more frequently than they have in the past, it would be helpful for investors to understand in greater detail the criteria that are applied to determine whether ‘significant’ changes have taken place.


ARE CAT BOND CREDIT


RATINGS STILL IMPORTANT? The issues surrounding the role of credit rating agencies and their


evaluation of complex securities during the 2007–2009 credit crisis have been well documented and go beyond the scope of this article. Based on Anchor Risk Advisors’ discussions with high-yield corporate bond portfolio managers in the aftermath of the credit crisis, it appears that their decision-making process has focused increasingly on fundamental credit analysis combined with reduced reliance on third-party rating agency analysis. At the same time, the percentage of cat bond investors that are not insurance specialists has declined from approximately 50 percent in 2007 to 22 percent, according to Swiss Re.


This trend leads to the question of whether or not cat bond credit ratings


are required in today’s market environment. Although cat bond transaction costs have come down materially over the last two decades, issuers still


Pete Vloedman is chief executive of Anchor Risk Advisors. He can be contacted at: pvloedman@anchorriskadvisors.com


November 2011 | INTELLIGENT INSURER | 39


cite cost as a consideration when pondering the issuance of a cat bond. With insurance specialists who perform their own fundamental analysis exceeding 70 percent of the cat bond investor base and non-insurance specialists reducing their reliance on credit ratings in their core businesses, it may be that the additional cost of the credit rating is not worth the marginal increase in investor distribution that is gained by the rating in the short run.


Cat bond investors without insurance expertise may struggle to understand


why a bond’s rating is so dependent on a statistical model, since in many other asset classes such a reliance is less commonly seen. Also, any increased volatility in cat bond credit ratings, to the extent that it is greater than that of typical corporate bonds, may be detrimental to the perception by non- insurance investors that cat bonds are typically more stable investments than traditional high-yield bonds. This could hurt the long-term goal of transferring commoditised catastrophe risk to the broader capital markets.


In summary, we applaud the diligence being shown by credit rating


agencies to ensure that their ratings are in line with the agency’s view of a cat bond’s current level of risk. We view the current focus on the impact of model change, especially when it does not relate to the risk calculation of a specific bond, as a modification of past practices and would encourage rating agencies to add additional disclosure to their rating methodologies, detailing their philosophies on catastrophe model changes and their impact on cat bond ratings.


It is our opinion that reduced investor reliance on rating agency data since


the credit crisis, combined with the current make-up of the cat bond investor base may reduce the need for cat bond credit ratings in the near term.


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