As climate risk escalates, insurers and reinsurers are increasingly relying on catastrophe modelling to navigate uncertainty.For insurance-linked securities (ILS) managers, these tools go beyond guidance, they are foundational to underwriting discipline, portfolio construction, and investor capital protection, according to a new report from LGT ILS Partners.In a new report, analysis from LGT ILS Partners, the specialist ILS team of LGT Capital Partners, notes that the catastrophe risk modelling tools used in reinsurance could be described as a kind of high-tech “crystal ball” that forecast natural disaster scenarios and quantify their potential financial impact.“Catastrophe risk modelling tools use historical data, scientific research and sophisticated computer simulations to predict the likelihood and potential severity of such disasters and the extent of the damage they could cause to the insured properties in the defined area,” the report reads.

This isn’t just theoretical forecasting, it’s a core input for underwriting strategy.“An ILS manager applies such models to first assess individual transactions on a stand-alone basis and to then assess the overall portfolio composition,” the report explains.Concurrently, the analysis also notes that modelling is also a key tool for protecting investors.

“Catastrophe risk modelling forms the basis for informed decision-making on single investments, supporting premium negotiations and optimizing combined risk portfolios in order to inform investors about the expected maximum draw-down from extreme hypothetical natural events.” However, sophisticated modelling is only half the equation.The other critical component lies in contract structuring, particularly how events are defined.The report points to the 2018 California wildfires (Camp and Woolsey Fires) as an example of how nuanced event definitions can materially affect loss outcomes.

“These events caused significant financial losses to the private insurance sector.The fact that the losses were triggered by more than one fire event highlights an area of potential dispute in the definition of an event: depending on the structure of the reinsurance cover, the insurance company buying the reinsurance protection may have an inherent interest in declaring this to be a single event,” the report notes.This impacts not only payout triggers but also who ultimately bears the loss, primary insurers, reinsurers, or ILS investors.

Furthermore, the analysis states that in order to manage these risks, experienced underwriters ensure that reinsurance contracts are drafted with precision, incorporating clear definitions of time and distance between events, as well as updated exclusion clauses, particularly in light of emerging risks such as war or government seizure of assets.“As a general rule, it is important for reinsurance contracts to be drafted in clear and precise language and to incorporate exclusion clauses to address emerging risks.Another current example relates to the exclusion of risks relating to war, with contractual terms having been amended to also exclude “warlike operations and the nationalization of property” rather than solely official declarations of war.” “Properly defining coverage limits, exclusions and conditions help to prevent misunderstandings and disputes ultimately protects the reinsurer from unexpected financial losses,” the report adds.

It’s important to remember that catastrophe risk models do more than assess peril, they empower ILS managers to align pricing, protection, and capital deployment.“The models are a powerful tool for deal underwriting, ultimately optimizing portfolios and protecting investors from undue losses,” the report states..All of our Artemis Live insurance-linked securities (ILS), catastrophe bonds and reinsurance can be accessed online.

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