The cat bond and reinsurance markets are likely to be affected by a new study by the US Geological Survey. It concludes that, in many places, there is a higher risk of earthquakes than was previously thought.
This weekend, the San Francisco Bay area experienced its largest earthquake for 25 years. Fortunately, there was no loss of life and the damage was limited, but it was a reminder that it is always earthquake season.
Every few years the USGS produces a comprehensive review of earthquake science that is used as the starting point for many of the models that are used to determine the price of reinsurance and cat bonds. New detailed maps show changes of up to 40% compared with the previous report published six years ago. This is likely to have a direct impact on the price of earthquake reinsurance.
The findings of this project are much more than a scientific curiosity for the reinsurance industry. These maps are fundamental building blocks for the catastrophe models that are used by insurers, reinsurers and cat bond investors. An elevated level of risk would mean that regulators and rating agencies will require insurance companies to buy more reinsurance or issue more cat bonds.
The market has seen this kind of dynamic before. In 2011, RMS updated their US hurricane model to incorporate the lessons from events such as Hurricane Ike (2008). This significantly increased RMS’s view of windstorm risk in some parts of the US – in particular some inland regions. These changes had a direct effect on reinsurance pricing. In fact, the market anticipated the model changes and reacted before the model was released.
Among the findings of the 2014 earthquake maps is the belief that larger earthquakes could strike the East Coast than had previously been identified. A magnitude 5.8 earthquake that struck Virginia in August 2011 was one of the events that steered geoscientists to this conclusion.
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