Prism�s Approach to Modeling Natural Catastrophe Risk

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					Prism’s Approach to Modeling Natural
Catastrophe Risk
Casualty Actuarial Society

November 12, 2007

Mark Rouck, CPA, CFA
Topics
Background on Prism

Prism’s Catastrophe Risk Component

What Does it Mean for Ratings?
Topics
Background on Prism

Prism’s Catastrophe Risk Component

What Does it Mean for Ratings?
The Road to Implementation                                           Prism
  US: November 2007        Nov-2007
                                                                      A robust, global, stochastic model for
                                                                       evaluating the capital adequacy of insurers
                                         Fully Implemented
                                         with “cure” period           Represents a significant step forward from
                                                                       existing regulatory and rating agency
                                                                       methodologies
                                         Late 06-Early 07

                                Beta Models tested and calibrated




                                       2nd QUARTER, 2006
                        Executive Summary of Methodology
                        Technical Document of Prism
                        Assessment of Insurer In-house Economic Capital Models
                        Defining Available Capital
                        Calibration to Rating Thresholds
                        Enterprise Risk Management

                                       PRIOR TO 2006

              Commits to building a Global Economic Capital Model (September 2004)
              Releases Variable Annuities Capital Model (August 2005)
              Publishes Catastrophic Risk and Capital Requirements (November 2005) and New
               Catastrophe Risk Analysis Increases Capital Needs by 10%. (May 2006)




                                                                                                                3
Prism’s Unique Strengths and Features

1. Global yet local
     Current list of countries: FR, GER, UK, US
     Consistent assumptions and structure allows us to bolt on others
     Recognizes country specific products and parameters

2. Integrated
     Risks are modeled simultaneously – captures both diversification and
      compounding effects
     Economic Scenario Generator / Correlated Random Numbers

3. Stochastic
       5,000 simulation scenarios
       T-VaR approach considers “tail” events
       Calibration based on historical default rates
       Wave of the future – Solvency 2
                                                                             4
Modeling Methods – Risk Elements Captured
    Underwriting Risk              Reserve Risk                 Catastrophe Risk              ALM (Market) Risk              Credit Risk
    Use a collective risk        Incorporates reserve         Use Company                 Incorporates risk-free      Incorporates defaults,
     model of frequency            adequacy analysis             Provided PMLs                yield curve (bonds,          migration and spread
     and severity of losses.      Use Mack Method to           Use AIR (Catrader)           mortgages), real             volatility
    Relies on ELR,                Estimate Volatility           software.                    estate and equity           Use common market
     Attachments, Limits          Utilize several checks       Consideration of up to       returns (DAX, FTSE,          indices to establish
    Factors one year of           to ensure data                1 in 10,000 event            CAC).                        parameters for asset
     new business.                 integrity                                                 Use a proprietary,           type and quality
                                  Asbestos &                                                 integrated scenario         Over 50 asset
                                   Environmental Losses                                       generator.                   buckets.
                                   Evaluated Separately                                                                   Stochastically model
                                                                                                                           reinsurer default risk




                                                                                                        “Aggregator”
                                                                                                           Consistent economic scenario set
          Each Company will
                                                                                                           Similar Cat event set
          potentially have
                                                                                                           Correlated random numbers
          unique risk curves




                                                                                                                                               5
Two Core Outputs Determine Prism Scores
1. Available Capital or “AC”
     Economic, not accounting based number
     What is amount of liquid capital in a controlled run-off situation
2. Required Capital or “RC”
     Distribution table produced by the simulation
     RC is not a single number but a range of outcomes
     Derived by applying the appropriate T-VaR against distribution
Simulation calculates PV of cash inflows and outflows over 30 year
   balance sheet run-off (with one year of new business)
     Cash outflows: claims and expenses
     Cash inflows: investment earnings and premiums on new business
Prism Score is point where AC intersects RC
     The highest rating level at which that occurs is your Prism Score

                                                                           6
    Capital “Score” Required vs. Available


                REQUIRED CAPITAL            FITCH AVAILABLE CAPITAL

                                                                   9,000,000
  Defined by
                                                                   8,000,000
Balance Sheet
                                                                   7,000,000
 Assessment
                                                                   6,000,000

                                                                   5,000,000

                                                                   4,000,000

                                                                   3,000,000
                                                                   2,000,000

                                                                   1,000,000

                                                                   0

         BBB-   BBB   BBB+   A-    A   A+   AA-   AA   AA+   AAA



                   Defined by
                  Model Results
                                                                               7
 Prism: 2006 US Non-Life Results


 Confirmed overall existing   PRISM SCORES: DISTRIBUTION AT YEAREND 2006
                               US: Non-Life Groups
  capital assessment of                             # of Non-Life Percent of Total
  Fitch universe               Prism Score         Insurer Groups       (%)
                                   AAA                     20                   47
 Limited (~10% of group’s         AA+                      7                   16
  reviewed) Prism related          AA                       2                    5
  rating actions                   AA-                      1                    2
                                   A+                       6                   14
 Certain sectors performed        A                        3                    7
  better than expected e.g.        A-                       4                    9
                                   BBB+                     0                     0
  personal auto                    BBB                      0                     0
                                   BBB-                     0                     0
                                 Non-investment
                                      grade                 0                 -
                               Total                       43                 100



                                                                                      8
Topics
Background on Prism

Prism’s Catastrophe Risk Component

What Does it Mean for Ratings?
Prism’s Catastrophe Risk Component
> Insurer provided modeled annual aggregate
  catastrophe losses at various return periods
   – Frequency / Severity Assumptions = Near-term
   – Demand Surge = Occurrence base
> AIR Catrader models gross annual aggregate
  catastrophe losses at various return periods based on
  by state premium distribution and AIR event sets
> Interpolation generates modeled annual aggregate
  gross loss distribution ranging from 20-10K year
  return periods

                                                      10
Prism’s Catastrophe Risk Component (cont.)

> Catastrophe reinsurance program applied against
  gross losses to create annual aggregate modeled net
  loss distribution
   – Alternatively will use insurers full net annual aggregate
     catastrophe loss distribution if provided
> Alternatives to traditional reinsurance (i.e. catastrophe
  bonds, ILWs) added to catastrophe reinsurance
  program based on perils and attachment points




                                                                 11
Prism’s Catastrophe Risk Component (cont.)

> Modeled net catastrophe losses combined with other
  risk components to determine each scenario’s
  additional capital needs
                                                 Asset    Added
         Asset    Net Investment          CAT   Balance Required
Year    Balance Premium Income Claims    Losses Ending Capital     NPV
 1          5,491 2,013    1,245 3,203      152    5,394     -       -
 2          5,394   -        216 2,017       -     3,593     -       -
  .           485   -         19   388       -       116
  .           116   -          4   153       -       (33)     33     22
 30            -    -        -      43       -       (43)     43     27
Total                                                                49



                                                                          12
Topics
Background on Prism

Prism’s Catastrophe Risk Component

What Does it Mean for Ratings?
What Does this Mean for Ratings?
> Capital required to support catastrophe risk varies by
  company and rating category
   – Fitch does not have single by rating category catastrophe
     exposure related capital requirements
               REQUIRED CAPITAL
    Stress Level     T-VaR    Total ($000)     2006
        AAA        99.8450%    14,934,448     70%
        AA+        99.7260%    13,329,592     78%
        AA         99.5890%    12,199,723     86%
        AA-        99.4090%    11,220,677     93%
        A+         99.2060%    10,304,747    101%
        A          99.0710%     9,590,155    109%
        A-         98.6840%     8,641,148    121%
        BBB+       96.7180%     6,604,306    158%
        BBB        95.1420%     5,411,341    193%
        BBB-       93.4310%     4,262,938    245%
        < BBB-     92.4120%     3,532,840    295%
    FITCH AVAILABLE CAPITAL:    9,675,413



                                                                 14
What Does this Mean for Ratings? (continued)

> Catastrophe related “stress test” implicitly considered
  through
   – Use of annual aggregate modeled catastrophe losses
   – T-VaR approach applied to overall required capital
     distribution
   – In unique cases, modeled catastrophe results can also be
     stressed by shifting company supplied or CATRADER
     generated loss distributions upward




                                                                15
Catastrophe Findings from 2005 Beta Testing

> Insurers with large homeowners or coastal property coverages
  have tremendous capital exposure to extreme tail events
    – For these insurers required capital can materially exceed 100 year
      and 250 year PML used in factor based models
> Others such as specialty liability underwriters have virtually no
  catastrophe exposure
> For universe in aggregate, catastrophe related required capital
  was equal to 8.9% of aggregate exposure
> Ignoring insurers without catastrophe exposure, range of required
  catastrophe capital / exposure was 6% - 37%




                                                                           16
Results of 2005 Beta Testing by Sector
                                                                                                        At highest rating
                                                                                                         level "passed"


                        Exposure:                                                                        Catastrophe
                      Aggregate New 100 year PML / AC 250 year PML / AC             5000 year PML / Required Capital /
Sector               Business ($000)*               **                **                      AC **        Exposure
Commercial Lines
 Large Cap                179,706,446              11.9%                17.7%               23.2%                 5.6%
 Regional                  14,698,229               8.9%                21.8%               39.3%                15.1%
 Specialty                 25,339,872               8.0%                13.4%               18.4%                 4.8%
  Subtotal                219,744,547               9.2%                16.5%               24.6%                 7.4%
Personal Lines
 National                 146,660,851              12.6%                19.7%               27.1%                11.2%
 Regional - Auto           12,872,352               7.3%                10.7%               16.9%                13.6%
   Subtotal               159,533,203              10.1%                15.5%               22.4%                12.3%
Total                     379,277,750               9.5%                16.2%               23.9%                 8.9%

* For consistency, premium figures have not been adjusted to reflect only those lines that are affected by catastrophes
**   PML = Probable Maximum Loss are Fitch's best estimate using AIR's Catrader software and our assessment of reinsurance
or Company-supplied figures.
*** Results are straight averages and are not weighted.




                                                                                                                             17
Takeaways

> Fitch uses Prism to determine capital requirements for natural
  catastrophe risk
> Prism considers modeled annual aggregate catastrophe loss
  distributions rather than select points along the distribution to
  develop capital requirements
> Capital required to support catastrophe risk varies by insurer and
  by rating category
> “Stress Tests” implicitly considered through annual aggregate
  and T-VaR approaches employed by Prism




                                                                      18
Dedicated Website: www.fitchratings.com/prism

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                                                19
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