Managing Catastrophe Exposures in Mexico: Country Experience

How Can Insurance Regulators and Government Policymakers manage catastrophe risk?

Manuel Aguilera-Verduzco

President of theInsurance and Surety National Commission (CNSF)

Catastrophic Risks

Insurance Regulation

Final Remarks

Seismic Risk

Contents

Catastrophic Risks

Mexico’s geographic situation makes it highly vulnerable to natural phenomena. Among the most important risks are:

Seismic

Volcanic Eruption

Hurricane and Hail - Flooding

Catastrophic Risks

Mexico is highly exposed to earthquakes’ occurrences due to the seismic fault located in the Southeast cost of the country.

Seismic risk in Mexico

Seismic activity in Mexico is one of the most important around the world.

Large earthquakes may cause significant human and economic losses and, potentially, put insurance companies in an insolvency position, especially if not proper regulation is in place.

Therefore, the Insurance and Surety National Commission (CNSF) recognised the need of a careful technical analysis of earthquakes’ effects in order to estimate the losses that may be caused by this kind of events.

Seismic risk in Mexico

The American Continent is divided into six earth fragments:

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1. North American Plate

2. Pacific Plate

3. Cocos Plate

4. Nazca Plate

5. Caribbean Plate

6. South American Plate

Seismic risk in Mexico

Mexico is located in a sub-duction region where several tectonic plates collide.

North AmericanPlate

Pacific Plate

Cocos Plate

Earthquakes in Mexico (1908-2003)

Magnitude > 6.5°

Year Magnitude* Year Magnitude*

1908 7.7 1985 8.1

1909 7.6 1986 7

1911 7.9 1989 6.9

1928 7.7 1993 6.6

1928 8 1994 6.6

1941 7.9 1995 7.4

1957 7.7 1995 8

1962 7.2 1997 7.3

1965 7.8 1999 7

1968 7.4 1999 7.4

1978 7.8 2000 7

1979 7.6 2003 7.6

* Richter Scale

Seismic risk in Mexico

The effects of the 1985 earthquake motivated the development of engineering studies and the revision to several by-laws:

New technological developments were used to evaluate and measure the phenomenon.

A new Building Code was implemented.

The EI-UNAM* developed a software in order to asses the seismic risk of Mexican insurance companies’ building portfolios.

Adjustments to the insurance regulation were implemented using new technical basis.

* EI – UNAM: Engineering Institute of the Universidad Nacional Autónoma de México (UNAM)

Insurance RegulationSeismic Risk

Insurance Regulation

The EI-CNSF System provides 2 elements:

Risk Premium

Probable Maximum Losses

It also offers the possibility to compute technical items like

the:unearned premium reserve, catastrophic reserve, and the solvency margin.

Insurance Regulation

Unearned Premium Reserve

It should be constituted with 100% of the risk premium (calculated by the EI-CNSF system).

Costs and Profit

Risk PremiumUnearned Premium Reserve

Is the amount of the unearned premium risk at the time of the valuation.

Insurance Regulation

Unearned Premium Reserve

It’s calculated by the system requiring a minimum of (mandatory) information in order to measure a building’s probability of damage in case of earthquake.

Risk Premium(RP)

Optional information

+

Conservative quota

Precisely quota

(reduction in the RP)

Optional InformationExample: Postal code,

latitude, use (commercial, residential, industrial), land irregularities, walls’ type,

open spaces, building date, etc.

Mandatory information

Mandatory InformationExample: Policy number, insurance term, insured

value, % of retention, seismic zone, building

type, etc.

Insurance Regulation Unearned Premium Reserve

As the premium is earned by the company, the reserve is released in that proportion and is used to increase the catastrophic reserve (in a monthly basis).

Catastrophic Reserve

Unearned Premium Reserve

Insurance Regulation

It was implemented after the experience of the 1985’s earthquake.

Catastrophic Reserve

It’s accumulation is confined by a technical limit determined by the Probable Maximum Loss (PML), calculated by the EI-CNSF system.

Is considered as a “long term unearned premium reserve”.

Insurance RegulationInsurance Regulation Catastrophic Reserve (CR)

Probable Maximum Loss

Scenario 1Scenario 1 Scenario nScenario n

2. Expected loss % for each structure

3. PML for each seismic scenario

4. Average of PML = Technical limit

% %

%

% %

%

Is defined as the total amount of expected portfolio losses during a single critical event and is calculated by the EI-CNSF System.

1. Different seismic scenarios

Scenario 2, Scenario 3, . . . ,Scenario 2, Scenario 3, . . . ,

PMLA

Insurance RegulationSolvency Margin

SR = R1 + R2

The Earthquake SR is defined as:

Technical requirement relative to the earthquake risks retained by the insurer

Requirement resulting of deficiencies in the proportional

risk cession +

Solvency Requirement (SR)

Insurance RegulationSolvency Margin

The Technical Requirement (R1) is defined as the Probable Maximum Loss (calculated by the EI-CNSF System) of a company’s portfolio (PMLC).

R1 = PMLC

Retained cumulus portfolio

Insurance RegulationSolvency Margin

The Requirement for the reinsurance’s proportional cession deficiencies (R2) is defined as the percentage of the retained premiums (PR) that were ceded to non-registered reinsurers* (PCNR) applied to the PMLC of the company’s portfolio.

R2 = PMLC * (PCNR/PR)

(Non-registered reinsurers index – 1)

* This register is granted by the Ministry of Finance to foreign reinsurers with a rating higher than: BBB- (Standard and Poor’s and Fitch); B+ or FRP= 5 (A.M. Best); or Baa3 (Moody’s).

Final Remarks

The Mexican experience in natural disasters had stimulated the process of regulation improvement, aimed to enhance the financial stance of insurance companies.

Final Remarks

The Seismic System is an example of the insurance regulators’ effort for managing catastrophic risks taking into account the long term financial viability.

Hurricanes’ frequency and severe effects make necessary the development of new technical basis for their regulation.

Nowadays, the EI-UNAM-CNSF is working out with a hurricanes’ research, in order to estimate their frequency and severity.

Our goal is to have a Hurricane System similar to the seismic one, taking into account Mexico’s specific characteristics.

Managing Catastrophe Exposures in Mexico: Country Experience

How Can Insurance Regulators and Government Policymakers manage catastrophe risk?

www.cnsf.gob.mx

maguilera@cnsf.gob.mx