Credit Risk
Myths and
about
by
Seismic
Eugene Trahern and Doug Silver
Since the 1980s, part of the due diligence for
properties in seismically active areas has included
an earthquake risk or seismic report. These reports are of particular interest to risk managers
and investors and are intended to help quantify
the potential losses to life-safety, real property,
and loss of revenue due to business interruption.
Over the years, so-called Probable Maximum
Loss (PML) reports have become a standard requirement of real estate investors and lenders,
but are increasingly provided merely to satisfy a
checklist for the closing process. Consequently,
the underlying risk assessment needs have been
lost in the process.
Background
An important tool in the real estate industry, seismic evaluation reports are used to assist in identifying and quantifying the risk of loss. Billions of
dollars are invested annually in the acquisition,
construction, and financing of properties, which
rely in part on seismic reviews prior to the closing
of the business agreement.
But even though many of the major financial
institutions have established seismic criteria, a
large disconnect remains between actual seismic
risk assessment needs and the quality of information provided. Additionally, many smaller lenders, such as regional and community banks, have
Illustrations by Kristina Trahern
34
May 2011 The RMA Journal
2011 Copyright by RMA
Reports
recently shown interest in
performing seismic risk
assessments, but are either
confused or led astray by
conflicting information.
Seismic reports have
developed over the past
30 years, resulting in a
variety of report products and definitions of
probable maximum loss.
In 1999, the American
Society for Testing and Mate- Seismic evaluation
rials (ASTM) published ASTM
E2026, “Standard Guide for the reports are an excellent
Estimation of Building Damage- risk management
ability in Earthquakes,” which
tool, but they must
provided standards for the procedures and definitions used in be prepared and
seismic reports. The companion used properly.
document, ASTM E2557, “Standard Practice for Probable Maximum Loss (PML) Evaluations for
Earthquake Due-Diligence Assessments,” was intended to establish
the standard for evaluating and classifying financial risks to real
estate improvements due to potential earthquake damage. While
these documents have gone a long way in setting the standards
for seismic loss estimation reports, many misconceptions remain
about these reports and their intended use.
ASTM E2026 addressed two fundamental issues regarding seismic reports: 1) providing a standard definition for seismic loss, and
2) defining various levels of investigation similar to environmental
(Phase I, II, etc.) due diligence. The term probable maximum loss
had taken on many different definitions, mostly related to the confidence level (mean or 90th percentile) and ground motion levels
being considered. While the document defines scenario expected
loss (SEL), scenario upper loss (SUL), and probable loss (PL) as standards for reporting, the use of PML in this article is intended as a
generalization of all loss estimation.
Common Myths
Hemera/Thinkstock
Seismic evaluation reports are an excellent risk management tool,
but they must be prepared and used properly. The following myths
and misconceptions regarding seismic reports are commonplace.
Myth 1: All seismic reports are created equal.
The primary difference that sets seismic reports apart is the level
of investigation. The ASTM documents define four levels of loss
estimation (levels 0–3), each with its own requirements. These
The RMA Journal May 2011
35
Seismic Zone of the Property and the Building Replacement Cost
Seismic Zone/UBC-97
0,1
2A, 2B
3
4
$0M<X=$5M
none
none
BS0, SS0, BD0
BS0, SS0, BD0
$5M<X=$15M
none
none
BS0, SS0, BD0
BS1, SS1, BD1
$15M<X=$50M
none
none
BS1, SS1, BD1
BS1, SS1, BD1
$50M<X=$100M
none
BS0, SS0, BD0
BS1, SS1, BD1
BS2, SS2, BD2
$100M<X
none
BS1, SS1, BD1
BS2, SS2, BD2
BS2, SS2, BD2
Where:
X = Building replacement cost
BS = Building stability assessment (determination of potential collapse)
SS = Site stability assessment (determination of site hazards such as liquefaction, etc.)
BD = Building damageability (determination of potential loss)
0, 1, 2, 3 = Level of investigation for each category
requirements include the building’s level of evaluation,
site conditions, ground motions, loss estimation, and the
reviewer’s qualifications. ASTM E2557 defines the levels of
review to be conducted for a building based on the seismic hazard zone and the value of the property (see table
above).
The major difference between seismic reports is the
level of investigation (and associated qualifications of the
reviewer) performed, which can range anywhere from a
desktop review ($500 to $1,000) to a three-dimensional
nonlinear dynamic analysis ($50,000) for the same building.
Level 0 reviews are most often performed by personnel not
necessarily specializing or having expertise in structural
engineering, while levels 1–3 require engineering analysis
(calculations) for the seismic capacity of the building.
Myth 2: A PML estimate under 20% indicates an acceptable
building.
Estimated seismic loss, or building damageability, is only
one aspect of the seismic risk of a building. Life-safety, or
building stability,
is the aspect most
often omitted in
seismic reports or
overlooked on the
investment end of
the deal. Risk to
life-safety and risk
of potential damage do not always
coincide, because it
is possible to have
high risk to lifesafety and low potential dollar loss,
and vice versa.
For example, if
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May 2011 The RMA Journal
an apartment complex has 20 buildings, one of which has
a soft-story condition that poses the potential for a collapse,
the estimated seismic loss for the project may be well under
20%, with the total loss of one building constituting only
5% of the overall property value. However, the potential
loss of life to the occupants of that one building remains
very high. The ASTM documents require an evaluation and
a written statement by the reviewing engineer regarding
the “building stability” in each report—a requirement that
is often omitted.
Myth 3: There is one correct method to determine loss.
Over the years, several methods have been developed for
estimating seismic loss. These methods are typically based
on professional or “expert” opinions of the amount of damage to a structure for various levels of ground motions and
specific building types. These loss estimation methods were
originally intended for use on large numbers of buildings,
not individual structures, and so were widely misused.
Common loss estimation methods include ATC-13, Thiel
and Zsutty, and proprietary software.
All of the loss estimation methods use a limited number
of building types, and each building type (for example,
mid-rise concrete shear wall) envisions some theoretical
“average” building. Buildings are frequently a combination of different types and are rarely average. It is the job
of the investigator to determine how the building under
consideration differs from the “average” building. Not only
should the loss estimation be modified using engineering
judgment based on the engineer’s analysis of the building,
but the uncertainty involved in the study should be indicated. With respect to the inherent uncertainty involved,
loss estimates that are provided with decimal point precision
imply a false sense of accuracy.
The key item in any report is that the method used should
be indicated and enough information provided to show
how the loss estimation was derived. Positive and negative
aspects that decrease or increase the loss estimation should
be included. Simply indicating numerical values that are
plugged into an equation is not sufficient.
Structural engineers tend to use either the ATC-13
methodology or proprietary software based on the ATC-13
method. This method provides statistical information that
can be adjusted for positive or negative aspects of the building design. Another method used (oftentimes by providers
that are not structural engineers) is the Thiel-Zsutty method.
This involves solving an equation by assuming values for
the various coefficients. Both methods should give similar
results if used and adjusted correctly.
Myth 4: Anyone can perform a seismic loss estimate.
During the development of the documents, there was great
debate on the ASTM committee concerning the credentials
of persons performing the loss estimation. Level 0 “desktop”
reviews permit anyone with some experience to perform
the review, but the preferred method is to engage a registered engineer familiar with the building system type. The
requirements increase with each level. The greatest abuses
in seismic report preparation are committed by registered
engineers who sign reports but 1) do not personally visit
the site, 2) do not personally conduct the evaluation, or 3)
work outside their area of expertise.
Imagine e-mailing a doctor and providing information
such as age, height, weight, and smoking history and sending along a photo of yourself. You then ask the doctor to use
this limited information to prepare a letter to your insurance
company indicating that you are healthy and estimating your
life expectancy. This situation is comparable to engineers
signing reports without firsthand experience of the property.
While this “level 0” health review may be adequate for establishing the rate structure for health or life insurance based on
thousands of individuals, it is not adequate to indicate the
health risk of the individual in question. The same is true
for the seismic risk of a particular building.
Many states consider seismic reports to be engineering
work, since the reports contain professional opinions, evaluations, and recommendations for the building. As such, state
law may require a report to be conducted by or under the
direct supervision of a professional engineer competent in
the area of expertise (building structures) and then signed
and sealed in a manner that is clearly attributable to the
licensee. To continue the above analogy, one would not seek
medical advice from a nonlicensed practitioner or a dentist
if one’s general health depended upon it.
Myth 5: There is one correct answer.
Unfortunately, there is no one correct answer. However,
if the building is reviewed by competent engineers, loss
estimations from those providers will not necessarily be
the same, but should be within a few percentage points of
each other (depending It is important to consider
on the level of effort and
the methodology used). the competing interests
The database for dam- in the due diligence
age is poor at best, and
field (this holds true
the judgment of each
engineer varies based for property condition,
on his or her experi- environmental, and
ence and findings with
the building. The loss seismic assessments).
estimate should be used
as an indicator of the level of seismic risk, not the actual
calculated loss for future events.
Myth 6: You can buy the answer you want.
This isn’t really a myth because it’s actually true. Unfortunately, unscrupulous engineers will always provide an
answer that qualifies a building for investment purposes.
The authors recently reviewed a non-ductile concrete frame
high-rise building (one of the highest seismic risk types) in
northern California, for which four seismic reports were
produced in the past five years.
Three of the reports estimated the scenario expected loss
to be in the range of 30–35% and recommended substantial
seismic upgrades owing to the potential for both damage
and collapse. Meanwhile, the fourth report gave a loss estimate of 19% and indicated there were no issues with the
building. During the site visit, the environmental consultant
said that his firm always uses a certain structural engineer
because he “always gives answers that meet the clients’
lending criteria.” Little do those environmental or structural
consultants understand that the reason for seismic criteria
is to identify high-risk properties, and they are not serving
the end users by downplaying the seismic risk.
It is also important to consider the competing interests in
the due diligence field (this holds true for property condition, environmental, and seismic assessments). Buyers and
lenders typically have established criteria based on accept-
The RMA Journal May 2011
37
able potential loss, such as loan-to-value ratios, and the
reports are intended to adequately identify the deficiencies
that could lead to high seismic risk.
Seller-commissioned reports often provide an overview of
the property and issues without going into depth of study.
Buyers are required to conduct their own due diligence. Brokers often have favorite providers who get assessments done
quickly and for a low fee, without discovering major issues
that may “kill the deal.” Engineers are driven to be cost- and
schedule-competitive, both of which limit the scope and
depth of review. While many of these factors are not directly
associated with “buying the answer you want,” they often
influence the quality and legitimacy of the evaluation.
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Conclusion
The myths listed above are intended to identify the most
common misconceptions and misuses of seismic reports in
the current marketplace. Despite a strong push by many real
estate investment leaders to raise the standard of practice,
many people continue to misuse seismic reports as a tool
to define risk.
Following established seismic evaluation protocol (such
as that defined by ASTM E2026 and E2557 or by in-house
established standards), conducting the appropriate level
of investigation, and using qualified engineering consultants will help define the actual seismic risk and provide
consistency in seismic reports. In-house quality assurance
reviews of the reports also can help in determining if the
seismic reports are adequate (a sample can be found at www.
seismic-report.com). There is also a current effort under
way by the Structural Engineers Association to develop a
“building ranking” system that could be used to further
define seismic risk.
For groups ranging from large institutional investors to
small lenders, seismic risk assessment reports can be a useful
tool in determining risk to the organization. The evaluation
reports are excellent risk management tools when properly
prepared and implemented (for example, they can be used
to filter out the high-seismic-risk properties), but an understanding of their purpose, use, and quality is important to
all parties involved in the real estate transaction. v
••
Eugene Trahern, PE, SE, ARM, is the principal of Cascade Crest Consulting Engineers and
a member of the ASTM committees on seismic loss estimation and seismic evaluation
of existing buildings. He has been performing seismic risk assessments for more than
20 years. He can be reached at cccengr@msn.com. Doug Silver, PE, SE, is a senior
structural engineer at Coffman Engineers and a previous principal at Seismic Design
Consultants. Silver is a member of the ASTM committee on seismic loss estimation
and has more than 25 years of experience in performing seismic risk assessments.
He can be reached at silver@coffman.com.
Visit the blog www.seismicguy.com for more information and “spilled milks”
about seismic risk assessments.
38
May 2011 The RMA Journal
RMA Journal readers can’t get enough of
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