CATASTROPHE RISK- Supervision

Caribbean Association of Insurance SupervisorsDecember 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

Agg

rega

te e

xpos

ure

Pro

babl

e M

axim

um

Loss

Assessed to a severity of

1 in 250 years

Reinsurance cover

High quality, liquid capital

≤ Insu

rer

Capital Adequacy – Catastrophe Risk

Agg

rega

te e

xpos

ure

Pro

babl

e M

axim

um

Loss

Assessed to a severity of

1 in 250 years

Reinsurance cover

High quality, liquid capital

≤ Insu

rer

STEP 1

Aggregate exposure to PML

STEP 2

Capital and Reinsurance

STEP 3

Compare PML to Capital & Reinsurance

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.

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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:

Modeling AgencyHurricane

US$ million

QuakeUS$ million

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% for 1 in 100 year

Private Sector

20% – 30%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

Aggre

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Exposu

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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• Covers severity?• Covers frequency?

How much capital is exposed?

High quality, liquid capital

Reinsurance

Insu

rer

Multi-line ReinsuranceAn Insurance Company Y.E. 31 March 2009

1m-

2m-

3m-

4m-

5m-

6m-

7m-

8m-

“Motor XL” “Catastrophe XL”

$6.5m xs $1m

Motor, Workers’ Comp, Employers Liab, TPL, CAR Liability

$500k xs $500k

All lines of business

90% QS, $1m per risk limit

Burglary, PA, Marine Cargo, Fidelity

$7.5m xs $750k + 1 Reinstatement

Fire, Homeowners, Motor, Business Interruption, CAR-material damage

90% QS, $4m per risk limit

Property, Business Interruption, CAR-material damage

Multi-line ReinsuranceAn Insurance Company Y.E. 31 March 2009

1m-

2m-

3m-

4m-

5m-

6m-

7m-

8m-

“Motor XL” “Catastrophe XL”

$6.5m xs $1m

Motor, Workers’ Comp, Employers Liab, TPL, CAR Liability

$500k xs $500k

All lines of business

90% QS, $1m per risk limit

Burglary, PA, Marine Cargo, Fidelity

$7.5m xs $750k + 1 Reinstatement

Fire, Homeowners, Motor, Business Interruption, CAR-material damage

90% QS, $4m per risk limit

Property, Business Interruption, CAR-material damage

Catastrophe Excess of Loss

2 Events; $6.75 million recoverable for each event.

Quota Share

$3.6 million recoverable for each “risk”

This is a small insurer with no gaps in reinsurance protection, but not much capital either.

Property ReinsuranceAnother Insurance Company Y.E. March 31, 2008

US$5m

US$35m

US$70m

Residential XL, $65m xs $5m

& 1 Reinstatement

Commercial XL, $30m xs $5m

& 1 Reinstatement

75% Quota Share.

$4m per risk limit, & subject to an agg. exposure limit

Umbrella Property Catastrophe $110m XS:

1. $70m Residential

2. $35m Commercial

3. QS Event Limits (15% Agg. Exp.)

& 1 Reinstatement

15% Max. Agg. Exp. Zone B $27.45m

US$180m

Per risk XL $7.5m XS $150k

Other RI to be used first.

US$3m

Property ReinsuranceAnother Insurance Company Y.E. March 31, 2008

US$5m

US$35m

US$70m

Residential XL, $65m xs $5m

& 1 Reinstatement

Commercial XL, $30m xs $5m

& 1 Reinstatement

Quota Share. Max of US$0.79m per risk

Umbrella Property Catastrophe $110m XS:

1. $70m Residential

2. $35m Commercial

3. QS Event Limits (15% Agg. Exp.)

& 1 Reinstatement

15% Max. Agg. Exp. Zone B $27.45m

US$180m

Per risk XL $7.5m XS $150k

Other RI to be used first.

Catastrophe Excess of Loss

2 Events; maximum of $175 million recoverable for each event.

Quota Share

75% QS, but:

1. Only 58% placed,

2. Aggregate limits were 3 times overwritten.

Gap in reinsurance protection. Vulnerability to attritional claims would consume capital. }

Catastrophe Risk

What do these examples tell us?

• Is it mostly about reinsurance?

Yet Another Insurance Company Y.E. March 31, 2007

 120,952Total capital and liabilities

5,392Current liabilities

 6,486Net retained profit / (loss) 4,694Taxation payable

3,223 698Trade & other payables

 Dividends51,028Non-current liabilities

 3,223Tax 1,790Deferred tax liability

 49,238Insurance contracts liabilities

9,709Profit before tax64,532Capital & reserves

 4,174Investment income 24,518Accumulated profit

 26,514Reserves

 5,535Underwriting result  13,500Share capital

(44,472)Equity & Liabilities

 18,557Other expenses

674Int. payable & similar chg. 120,952Total Assets

 13,233Commissions paid49,485Current assets

 12,008Claims inc. less RI recvble. 15,556Cash & cash equivalents

 952Prepymts. & other debtors

1,943Commissions received 14,902Due from related parties

48,064Premiums earned 18,075Trade & other receivables

 (757)+/- in unexpired risk71,467Non-current assets

 (7,572)+/- in unearned premium 50,605Investments

 56,393Premiums less RI prem. 20,862Property, Plant, Equipment

Assets

$'000Income Statement$'000Balance Sheet

Yet Another Insurance Company Y.E. March 31, 2007

 120,952Total capital and liabilities

5,392Current liabilities

 6,486Net retained profit / (loss) 4,694Taxation payable

3,223 698Trade & other payables

 Dividends51,028Non-current liabilities

 3,223Tax 1,790Deferred tax liability

 49,238Insurance contracts liabilities

9,709Profit before tax64,532Capital & reserves

 4,174Investment income 24,518Accumulated profit

 26,514Reserves

 5,535Underwriting result  13,500Share capital

(44,472)Equity & Liabilities

 18,557Other expenses

674Int. payable & similar chg. 120,952Total Assets

 13,233Commissions paid49,485Current assets

 12,008Claims inc. less RI recvble. 15,556Cash & cash equivalents

 952Prepymts. & other debtors

1,943Commissions received 14,902Due from related parties

48,064Premiums earned 18,075Trade & other receivables

 (757)+/- in unexpired risk71,467Non-current assets

 (7,572)+/- in unearned premium 50,605Investments

 56,393Premiums less RI prem. 20,862Property, Plant, Equipment

Assets

$'000Income Statement$'000Balance Sheet Fixed Assets $21million

Net Asset Value $65million

•Fixed assets are illiquid and cannot be used to pay any claims.

•This balance sheet is top-heavy with fixed assets, and the real working capital is only $44million.

•Investment property to back catastrophe claims introduces CORRELATED RISK ON BOTH SIDES OF THE BALANCE SHEET.

Catastrophe Risk

What does this examples tell us?

Asset quality leaves something to be desired!!

Catastrophe Risk – Capad Step 2

Previously:

Catastrophe reinsurance may:• have gaps• not cover a plausibly severe hurricane• not cover enough hurricanes

• Working capital may be insufficient in quality & quantity.

To understand the assets, we need:

•Standard assessment of reinsurance

•Standard liquid asset definition

Catastrophe Excess of Loss

2 Events; maximum of $175 million recoverable for each event.

Quota Share

75% QS, but:

1. Only 58% placed,

2. Aggregate limits were 4 times overwritten.

Gap in reinsurance protection. Vulnerability to attritional claims would consume capital.

Fixed Assets $21million

Net Asset Value $65million

Fixed assets are illiquid and cannot be used to pay any claims.

•This balance sheet is top-heavy with fixed assets, and the real working capital is only $44million.

•Investment property to back catastrophe claims

introduces CORRELATED RISK ON BOTH SIDES OF THE BALANCE SHEET.

Catastrophe Risk – Capad Step 3

Pro

bable

Maxim

um

Lo

ss

Insu

rer <Reinsurance to cover plausibly severe

loss scenario - CONSISTENTLY ASSESSED

High quality, liquid capital

Catastrophe Risk – Capad Step 4Planning and Executing

&Supervising

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Underwriting

Supervising

Assumptions used to arrive at PMLs must be translated into underwriting guidelines

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.

CONSISTENCY BETWEEN PML ASSUMPTIONS & UNDERWRITING GUIDELINES – test during onsite inspection.

Planning

Catastrophe Risk – the local market

• OECS – Financial Sector.• Now, say, 150 non-life insurers.• Many underwrite catastrophe business in the region

102 Non-life &

composites in OECS in

2002

Catastrophe Risk – What next?

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?

Supervision & policyholder protection can be enhanced by adopting common standards and with greater sharing of

supervisory information. What information?

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!