S&P Puts Some Cat Bonds on CreditWatch After Model Changes

June 5, 2006

Standard & Poor’s Ratings Services has revised its criteria for rating natural peril catastrophe bonds with U.S. hurricane risk exposure. As a result, some catastrophe bond deals have been placed on CreditWatch with negative implications.

Some of the bonds issued by the following companies are affected:
Swiss Re

“The change has been prompted by recent actions taken by catastrophe modeling firms, principally Applied Insurance Research (AIR), EQE International’s EQECAT, and Risk Management Solutions (RMS), to update their calculations of expected loss,” S&P explained. “AIR and EQECAT are offering a near-term view of expected loss in addition to their longer term view. RMS continues to provide one view, but its time horizon has changed to be nearer term, reflecting the increased frequency and severity of Atlantic Basin storms.

“S&P also indicated that where “a modeling agency provides more than one view of expected loss on a portfolio of catastrophe risk,” it “will use the most conservative view in developing an opinion of the notes’ probability of attachment. Currently, that equates to selecting the probabilities of attachment under the shorter term view of expected loss, but it is reasonable to assume that in periods of benign activity the most conservative view would be obtained by using the longer term perspective.”

“For catastrophe bonds that have an exposure period greater than one year and the modeling firm or firms have made significant changes to the assessment of expected loss, Standard & Poor’s will request the sponsoring insurance company to rerun the catastrophe portfolio using the most current model version for rating purposes only.”

The rating agency noted that “exposure models that were run at the time of issuance and used to reset probabilities of attachment annually will remain escrowed over the life of the note. For the notes that have been placed on CreditWatch negative, we will be working with the sponsoring insurance company to gauge the feasibility of running the expected loss under the most current updated models and calculating the notes’ probability of attachment. If the companies are unable or unwilling to offer these services, then Standard & Poor’s will conservatively estimate the expected loss and its implications on the notes’ probability of attachment.”

S&P also said it “understands that the cost structure never captured the additional cost of running newer models–as historically the escrowed models reasonably captured the risk of attachment–and we do not intend to place an unnecessary burden on the special-purpose vehicle that issued the notes. We expect to lower the ratings on the notes by one to two notches in most cases due to the criteria change.”

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