SEL versus SUL: managing seismic risk in commercial real estate investments

Two common scenario loss ratios are used when calculating Probable Maximum Losses from earthquakes: Scenario Expected Loss (SEL) and Scenario Upper Loss (SUL). Analyses of seismic loss ratios prepared by five seismic consulting firms, four loan pools securitized in the capital markets, two very large loans with many properties, two large hospitality portfolios and a general account portfolio indicate that use of SUL rather than SEL would yield significantly larger numbers of loans with loss ratios in excess of 20%. When using SEL, the percentage of loans in the four large pools exceeding a 20% loss ratio was 3.8%. When SUL was used on this same data set, 47.8% of these properties had SUL values above 20%. Common industry practice has been to use SEL. Some of the implications of tightening seismic underwriting standards to apply a 20% threshold to the SUL, rather than SEL, may include: lower loan production, properties may lose value, properties may be costlier and more difficult to finance, existing loan portfolios may appear more seismically risky, and demand for insurance and seismic retrofit could go up. Equally undesirable effects could be that seismic consultants and lenders who do more rigorous analysis will be less competitive than those who do not. Copyright (c) 2010 John Wiley & Sons, Ltd.