Probable Maximum Loss Reports for Lenders

In today’s market lenders must actively manage all type of risk to their portfolio, including seismic risk. The lender’s tool of choice of managing seismic risk is Probable Maximum Loss (PML) reports. The PML predicts the amount of damage a building will experience with the 475-year earthquake happens. The damage is expressed as a percentage of the replacement cost. Most lenders consider a 20% PML an unacceptable risk without some other sort of mitigation such as insurance.

PMLs are a tricky product for lenders and real estate investors as there is more than one way to calculate a PML. Methods employed to calculate the PMLs vary significantly. Recently, ASTM has published two standards ASTM 2026-2007 and ASTM 2557-2007 to address this issue. By following these standards a more consistent product will be delivered, but the ASTM Standards do not go far enough. ASTM 2026-2007 is very flexible—it is more or less a set of definitions and a tool box so that engineers can at least use terms consistently. ASTM 2557-2007 provides specific recommendations for lenders.

Lenders should insist that their engineers provide PML Reports transparent, understandable, and consistent with others in the standards of the financial industry. One way to achieve transparency is by requiring engineers to show the math. Giving a PML result without showing how it was derived makes conducting a peer review difficult.

The last piece of advice for lenders is to work with an engineering firm with a registered engineer. Ordering engineering report like a PML from an environmental consulting firm is generally a mistake. The practice of structural assessment and PML modeling is clearly in the domain of the engineering profession.

Probable Maximum Loss Reports are a great tool to manage your seismic risk; however, be careful with this product as PMLs are not as standardized as other due diligence products such as Phase I Environmental Site Assessments and Property Condition Assessments.