Expected loss on an ILS tranche

The expected loss of a securitized tranche is the average annual loss the model projects on that tranche, expressed against its principal. It is the technical cost of the risk transferred and anchors every price discussion: the spread paid divided by this expected loss gives the multiple, the only figure allowing notes on different perils to be compared. It makes heterogeneous instruments comparable. A Japanese earthquake note and a Florida hurricane note have nothing in common except that each can be related to its technical cost. An independent modeling firm mandated at issuance produces the figure, and publishing it in the prospectus puts that firm's reputation behind it. It stays highly sensitive to assumptions: from one model generation to the next, published expected losses have shifted by thirty to fifty percent on some perils, with no change in the underlying physical risk.