How do financial institutions manage the seismic risk of their portfolios?
The short answer is, many of them do not. Many institutions have no formal seismic risk policy to screen out higher-risk properties, and even within those that do have a policy, Seismic Risk Assessments can be a source of confusion.
“Probable Maximum Loss” reports, also called “Seismic Risk Assessments” are an often misunderstood but very important tool in the underwriting toolkit for structured finance. These risk assessments rate buildings for seismic risk, the goal of which is to protect your portfolio and downstream investors from a double helping of seismic risk. The PML Report cannot completely eliminate risk from a seismic event, but the PML will screen out buildings that are at greatest risk for damage during an earthquake. Note: lenders that don’t require PMLs might find that their portfolio suffers from adverse selection; essentially getting a double helping of seismic risk.
To use the Probable Maximum Loss Report well a lender needs consistency. If you are going to measure anything, you want to do it by the same method every time. Seems like common sense, but the way the seismic risk assessment standards are written (ASTM E 2026-07 and E 2557-07) allows for numerous different types of assessments, scopes of work, and ways to report the PML value. So, lenders really need to play an active role in defining what they want in their seismic risk policy.
I recently participated in a webinar panel on how lenders can better understand and use PMLs, and structure a seismic risk policy. It is available to view on demand until January 31, click here to sign up.