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CATASTROPHE RISK - Supervision

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.

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CATASTROPHE RISK - Supervision

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  1. CATASTROPHE RISK- Supervision Caribbean Association of Insurance Supervisors December 5, 2008 Nigel Davies

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

  3. Catastrophe Risk

  4. Catastrophe Risk

  5. Catastrophe Risk

  6. Catastrophe Risk Implications for us? A few examples………………

  7. Capital Adequacy – Catastrophe Risk Assessed to a severity of 1 in 250 years Aggregate exposure Reinsurance cover ≤ Insurer Probable Maximum Loss High quality, liquid capital

  8. Capital Adequacy – Catastrophe Risk STEP 1 Aggregate exposure to PML STEP 2 Capital and Reinsurance STEP 3 Compare PML to Capital & Reinsurance Assessed to a severity of 1 in 250 years Aggregate exposure Reinsurance cover ≤ Insurer Probable Maximum Loss High quality, liquid capital

  9. 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. Aggregateexposure PML

  10. 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 surgeis 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?

  11. 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?

  12. 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:

  13. Catastrophe Risk – Capad Step 1 Typical PMLs: Public Sector1 45% – 70% for 1 in 100 year Private Sector 20% – 30% for various severity levels 1Details in oas.org/cdmp (Dominica, St. Kitts & Nevis and St. Lucia) Also, information on CCRIF available at www.worldbank.org Aggregate Exposure PML

  14. 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

  15. Catastrophe Risk – Capad Step 2 Capital & Reinsurance Capital • Sufficiency? • Quality? Reinsurance • Covers severity? • Covers frequency? How much capital is exposed? Reinsurance Insurer High quality, liquid capital

  16. Multi-line ReinsuranceAn Insurance Company Y.E. 31 March 2009 “Motor XL” “Catastrophe XL” $7.5m xs $750k + 1 Reinstatement Fire, Homeowners, Motor, Business Interruption, CAR-material damage 8m- $6.5m xs $1m Motor, Workers’ Comp, Employers Liab, TPL, CAR Liability 7m- 6m- 5m- $500k xs $500k All lines of business 4m- 3m- 90% QS, $4m per risk limit Property, Business Interruption, CAR-material damage 2m- 1m- 90% QS, $1m per risk limit Burglary, PA, Marine Cargo, Fidelity

  17. Multi-line ReinsuranceAn Insurance Company Y.E. 31 March 2009 “Motor XL” “Catastrophe XL” 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. $7.5m xs $750k + 1 Reinstatement Fire, Homeowners, Motor, Business Interruption, CAR-material damage 8m- $6.5m xs $1m Motor, Workers’ Comp, Employers Liab, TPL, CAR Liability 7m- 6m- 5m- $500k xs $500k All lines of business 4m- 3m- 90% QS, $4m per risk limit Property, Business Interruption, CAR-material damage 2m- 1m- 90% QS, $1m per risk limit Burglary, PA, Marine Cargo, Fidelity

  18. Property ReinsuranceAnother Insurance Company Y.E. March 31, 2008 US$180m • Umbrella Property Catastrophe $110m XS: • $70m Residential • $35m Commercial • 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

  19. Property ReinsuranceAnother Insurance Company Y.E. March 31, 2008 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. US$180m • Umbrella Property Catastrophe $110m XS: • $70m Residential • $35m Commercial • 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 } Quota Share. Max of US$0.79m per risk

  20. Catastrophe Risk What do these examples tell us? • Is it mostly about reinsurance?

  21. 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

  22. 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 • 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.

  23. Catastrophe Risk What does this examples tell us? Asset quality leaves something to be desired!!

  24. Catastrophe Risk – Capad Step 2 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. Previously: Catastrophe reinsurance may: • 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. • This balance sheet is top-heavy with fixed assets, and the real working capital is only $44million. • Investment property to back catastrophe claims introducesCORRELATED RISK ON BOTH SIDES OF THE BALANCE SHEET. • To understand the assets, we need: • Standard assessment of reinsurance • Standard liquid asset definition

  25. Catastrophe Risk – Capad Step 3 Reinsurance to cover plausibly severe loss scenario - CONSISTENTLY ASSESSED < Insurer Probable Maximum Loss High quality, liquid capital

  26. Catastrophe Risk – Capad Step 4 Planning and Executing & Supervising Aggregate exposure • 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. PML Planning Underwriting

  27. Catastrophe Risk – the local market 102 Non-life & composites in OECS in 2002 • OECS – Financial Sector. • Now, say, 150 non-life insurers. • Many underwrite catastrophe business in the region

  28. Catastrophe Risk – What next? • Have all catastrophe perils been modeled, considered? Wind, storm surge, flooding, landslide, quake… • Reasonable frequency & severity? 2 or 3 events in a year? Severity level of 1 in 100 years, 1 in 250 years? • Are PMLs reasonable & generally consistent with other insurers? • Are PML assumptions translated into underwriting guidelines? • Is capital & reinsurance adequate to cover PMLs? • Is capital quality acceptable for catastrophe risk? • Is reinsurance of acceptable quality? Supervision & policyholder protection can be enhanced by adopting common standards and with greater sharing of supervisory information. What information?

  29. 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?

  30. Thank you!

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