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CATASTROPHE RISK

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					               CATASTROPHE RISK
                  - Supervision
Caribbean Association of Insurance Supervisors
December 5, 2008

Nigel Davies
                  Catastrophe Risk

- Number of events nearly doubled since 1980’s
- Increase due to windstorm & floods
Catastrophe Risk
Catastrophe Risk
Catastrophe Risk
  Catastrophe Risk




  Implications for us?

A few examples………………
Capital Adequacy – Catastrophe Risk



                                         Assessed to a severity of
                                                  1 in 250 years
 Aggregate exposure




                      Probable Maximum




                                                                               Reinsurance cover


                                                          ≤          Insurer
                                           Loss




                                                                                High quality, liquid
                                                                                      capital
Capital Adequacy – Catastrophe Risk



                      STEP 1
                                                          Assessed to a severity of
                                          1 to PML
                         Aggregate exposure in 250 years
                      STEP 2
                         Capital and Reinsurance
 Aggregate exposure




                      STEP 3
                         Compare PML to Capital & Reinsurance
                                       Probable Maximum




                                                                                                Reinsurance cover


                                                                        ≤             Insurer
                                                            Loss




                                                                                                 High quality, liquid
                                                                                                       capital
      Catastrophe Risk – Capad Step 1

                  Aggregate Exposure                PML

• Aggregate exposure = sums insured on all catastrophe
  exposed policies.
   • Analyze by line of business and geographical location


• Assumptions (usually based on catastrophe models)
  determine the likely loss under scenarios of different
  severity.
   • Examples: 1 in 100 year severity, 1 in 250 year severity.




                                                     Aggregate
                                                     exposure




                                                                 PML
     Catastrophe Risk – Capad Step 1

                 Aggregate Exposure              PML

• Recording aggregate exposure – insurer’s discretion on
  line of business analysis.

BUT:
• No common modeling criteria.
  • Storm surge is accounted for by some modeling agencies – others are
    confined to windstorm damage.
• No common measure of severity.
  • 1 in 100 years?
  • 1 in 250 years?
  • How many times in a century does do we really get a 1 in 100 year
    hurricane season?
                    Reinsurance

     Modeling Severity of Loss Scenarios / Return Periods
                          - are they reliable?




Do supervisors really understand…


• difference between a 1 in 100 year & 1 in 250 year loss scenario?


• perils modeled by different modeling agencies?
                   Reinsurance
An example of modeling agency output:
For the same Caribbean insurer, using the same input, three
different agencies produced these estimates for a 1 in 200
year loss scenario:


                                    Hurricane      Quake
                                     US$ million   US$ million
             Modeling Agency

         RMS                         229.5            62.2
         EQECAT                      149.7         151.2
         AIR                         529.9            82.8
   Catastrophe Risk – Capad Step 1

Typical PMLs:
                               Public Sector1
                               45% – 70%




                                                                    Aggregate Exposure
                                   for 1 in 100 year


                               Private Sector
                               20% – 30%




                                                                                         PML
                               for various severity levels




1 Details in oas.org/cdmp (Dominica, St. Kitts & Nevis and St. Lucia)
  Also, information on CCRIF available at www.worldbank.org
      Catastrophe Risk – Capad Step 1


Previously:

• Flood & windstorm events have doubled
  in number over last 20 years
• Economic & insured losses rising very
  rapidly

 To understand the risks, we need:
 •Standard modeling criteria
 •Standard severity level
     Catastrophe Risk – Capad Step 2

                    Capital & Reinsurance

Capital
   • Sufficiency?
   • Quality?                               Reinsurance




                                Insurer
Reinsurance
                                            High quality, liquid
   • Covers severity?                             capital
   • Covers frequency?




How much capital is exposed?
                Multi-line Reinsurance
      An Insurance Company Y.E. 31 March 2009


          “Motor XL”                          “Catastrophe XL”

                                                        $7.5m xs $750k + 1
8m-                                                     Reinstatement
                                                        Fire, Homeowners, Motor,
                     $6.5m xs $1m                       Business Interruption,
7m-
                                                        CAR-material damage
                     Motor, Workers’ Comp,
6m-                  Employers Liab, TPL,
                     CAR Liability

5m-
                     $500k xs $500k
4m-                  All lines of business


3m-

                                              90% QS, $4m per risk limit
2m-
                                              Property, Business
                                              Interruption, CAR-material
                                              damage
1m-

       90% QS, $1m per risk limit
       Burglary, PA, Marine Cargo, Fidelity
                      Multi-line Reinsurance
            An Insurance Company Y.E. 31 March 2009


                “Motor XL”
Catastrophe Excess of Loss                           “Catastrophe XL”

2 Events; $6.75 million recoverable for                        $7.5m xs $750k + 1
                                                               Reinstatement
each event.
 8m-

                                                               Fire, Homeowners, Motor,
                            $6.5m xs $1m                       Business Interruption,
 7m-
                                                               CAR-material damage
                            Motor, Workers’ Comp,
Quota Share
 6m-                        Employers Liab, TPL,
                            CAR Liability
$3.6 million recoverable for each “risk”
 5m-
                            $500k xs $500k
 4m-                        All lines of business
This is a small insurer with no gaps in
reinsurance protection, but not much
  3m-

capital either.                                      90% QS, $4m per risk limit
 2m-
                                                     Property, Business
                                                     Interruption, CAR-material
                                                     damage
 1m-

              90% QS, $1m per risk limit
              Burglary, PA, Marine Cargo, Fidelity
                                              Property Reinsurance
          Another Insurance Company Y.E. March 31, 2008
US$180m



                                         Umbrella Property Catastrophe $110m XS:
                                         1.   $70m Residential
                                         2.   $35m Commercial
                                         3.   QS Event Limits (15% Agg. Exp.)
                                                        & 1 Reinstatement




US$70m

 Residential XL, $65m xs $5m
     & 1 Reinstatement


US$35m                                                                 15% Max. Agg. Exp.
                                                                       Zone B $27.45m
                                  Commercial XL, $30m xs $5m
                                        & 1 Reinstatement
                                                                                Per risk XL $7.5m XS $150k
                                                                                 Other RI to be used first.
US$5m

US$3m
          75% Quota Share.
          $4m per risk limit, & subject to an agg. exposure limit
                                           Property Reinsurance
          Another Insurance Company Y.E. March 31, 2008
US$180m                                                                                    Catastrophe Excess of Loss
                                                                                           2 Events; maximum of $175
                                      Umbrella Property Catastrophe $110m XS:
                                                                                           million recoverable for each
                                      1.    $70m Residential
                                      2.    $35m Commercial
                                                                                           event.
                                      3.    QS Event Limits (15% Agg. Exp.)
                                                    & 1 Reinstatement

                                                                                           Quota Share
                                                                                           75% QS, but:
US$70m                                                                                     1. Only 58% placed,
 Residential XL, $65m xs $5m
     & 1 Reinstatement
                                                                                           2. Aggregate limits were 3
                                                                                           times overwritten.
US$35m
                                                                    15% Max. Agg. Exp.
                                                                    Zone B $27.45m
                                Commercial XL, $30m xs $5m
                                      & 1 Reinstatement                                     Gap in reinsurance protection.
                                                                              Per risk XL $7.5m XS $150k
                                                                                            Vulnerability to attritional
                                                                               Other RI to be used first.



                                                                 }
US$5m
                                                                                            claims would consume capital.

            Quota Share. Max of US$0.79m per risk
     Catastrophe Risk




What do these examples tell us?

• Is it mostly about reinsurance?
 Yet Another Insurance Company Y.E. March 31, 2007

                   Balance Sheet                          $'000                         Income Statement                     $'000
Assets
Property, Plant, Equipment                                   20,862     Premiums less RI prem.                                  56,393
Investments                                                  50,605     +/- in unearned premium                                 (7,572)
                                  Non-current assets         71,467     +/- in unexpired risk                                        (757)
Trade & other receivables                                    18,075                                     Premiums earned         48,064
Due from related parties                                     14,902     Commissions received                                     1,943
Prepymts. & other debtors                                         952
Cash & cash equivalents                                      15,556     Claims inc. less RI recvble.                            12,008
                                      Current assets         49,485     Commissions paid                                        13,233
Total Assets                                                120,952     Int. payable & similar chg.                                   674
                                                                        Other expenses                                          18,557
Equity & Liabilities                                                                                                           (44,472)
Share capital                                                13,500                                    Underwriting result       5,535
Reserves                                                     26,514
Accumulated profit                                           24,518     Investment income                                        4,174
                                   Capital & reserves        64,532     Profit before tax                                        9,709
Insurance contracts liabilities                              49,238
Deferred tax liability                                        1,790     Tax                                                      3,223
                              Non-current liabilities        51,028     Dividends
Trade & other payables                                            698                                                            3,223
Taxation payable                                              4,694     Net retained profit / (loss)                             6,486
                                    Current liabilities       5,392
Total capital and liabilities                               120,952
 Yet Another Insurance Company Y.E. March 31, 2007

                   Balance Sheet                          $'000                    Fixed Assets $21million
                                                                                     Income Statement                   $'000
Assets
Property, Plant, Equipment                                   20,862     Premiums less RI prem.                             56,393
Investments                                                  50,605
                                                                                   Net Asset Value $65million
                                                                        +/- in unearned premium                            (7,572)
                                  Non-current assets         71,467     +/- in unexpired risk                                   (757)
Trade & other receivables                                    18,075                                   Premiums earned      48,064
Due from related parties                                     14,902     Commissions received                                1,943
Prepymts. & other debtors                                         952              •Fixed assets are illiquid and
Cash & cash equivalents                                      15,556     Claims inc.cannot be used to pay any 12,008
                                                                                   less RI recvble.
                                      Current assets         49,485
                                                                                   claims.
                                                                        Commissions paid                         13,233
Total Assets                                                120,952     Int. payable & similar chg.                              674

                                                                                   •This balance sheet is top- 18,557
                                                                        Other expenses
Equity & Liabilities
                                                                                   heavy with fixed assets, and   (44,472)
Share capital                                                13,500                           Underwriting result    5,535
Reserves                                                     26,514
                                                                                   the real working capital is
Accumulated profit                                           24,518     Investment only $44million.
                                                                                   income                            4,174
                                   Capital & reserves        64,532     Profit before tax                                   9,709
Insurance contracts liabilities                              49,238
                                                                                   •Investment property to
Deferred tax liability                                        1,790     Tax        back catastrophe claims                  3,223
                              Non-current liabilities        51,028     Dividends introduces CORRELATED
Trade & other payables                                            698              RISK ON BOTH SIDES OF                    3,223
Taxation payable                                              4,694
                                                                                   THE BALANCE SHEET.
                                                                        Net retained profit / (loss)                        6,486
                                    Current liabilities       5,392
Total capital and liabilities                               120,952
       Catastrophe Risk




 What does this examples tell us?



Asset quality leaves something to be
                desired!!
       Catastrophe Risk – Capad Step 2
                                            Catastrophe Excess of Loss
                                            2 Events; maximum of $175 million recoverable for each
                                            event.
                                            Quota Share



Previously:
                                            75% QS, but:
                                            1. Only 58% placed,
                                            2. Aggregate limits were 4 times overwritten.

                                            Gap in reinsurance protection.
                                            Vulnerability to attritional claims

Catastrophe reinsurance may:                would consume capital.



   • have gaps
   • not cover a plausibly severe hurricane
   • not cover enough hurricanes
• Working capital may be insufficient in
  quality & quantity.                  Fixed Assets $21million
                                       Net Asset Value $65million
                                       Fixed assets are illiquid and cannot be used to pay any claims.

 To understand the assets, we need:    •This balance sheet is top-heavy with
                                       fixed assets, and the real working capital is only
 •Standard assessment of reinsurance   $44million.

                                       •Investment property to back catastrophe claims introduces
 •Standard liquid asset definition     CORRELATED RISK ON BOTH SIDES
                                       OF THE BALANCE SHEET.
Catastrophe Risk – Capad Step 3




Reinsurance to cover plausibly severe loss




                                                           Probable Maximum Loss
scenario - CONSISTENTLY ASSESSED
                                                       <
                                             Insurer
 High quality, liquid capital
 Catastrophe Risk – Capad Step 4
                             Planning and Executing
                                       &
                                  Supervising




                                                                Aggregate exposure
                      Supervising




                                                                                     PML
Assumptions used to arrive at PMLs must be
translated into underwriting guidelines
                                                                           Planning
Examples:
   Number and value of shoreline properties insured –
   vulnerable to storm surges.
   Number and value of properties in quake zone & whether
   they are constructed or retro-fitted to withstand quakes.
                                                               Underwriting

CONSISTENCY BETWEEN PML
ASSUMPTIONS & UNDERWRITING
GUIDELINES – test during onsite inspection.
   Catastrophe Risk – the local market
                                              102 Non-life
                                              & composites
                                               in OECS in
• OECS – Financial Sector.                        2002
• Now, say, 150 non-life insurers.
• Many underwrite catastrophe business in the region
     Catastrophe Risk – What next?
   Supervision & policyholder protection can be enhanced by adopting
 common standards and with greater sharing of supervisory information.
                         What information?

1.   Have all catastrophe perils been modeled, considered? Wind,
     storm surge, flooding, landslide, quake…
2.   Reasonable frequency & severity? 2 or 3 events in a year?
     Severity level of 1 in 100 years, 1 in 250 years?
3.   Are PMLs reasonable & generally consistent with other
     insurers?
4.   Are PML assumptions translated into underwriting guidelines?
5.   Is capital & reinsurance adequate to cover PMLs?
6.   Is capital quality acceptable for catastrophe risk?
7.   Is reinsurance of acceptable quality?
Catastrophe Risk – What next?

A coordinated project to ……



• Standardize supervisory techniques


• Enhance exchange of information


would address these issues for all of us concerned…


……….Any comments?
Thank you!