This presentation has been prepared for the 2016 …...This presentation has been prepared for the 2016 General Insurance Seminar. The Institute Council wishes it to be understood

This presentation has been prepared for the 2016 General Insurance Seminar.The Institute Council wishes it to be understood that opinions put forward herein are not necessarily

those of the Institute and the Council is not responsible for those opinions.



Catastrophe Model Assumptions,

Uncertainty And

Reinsurance Structure Response

Charles Pollack



FCR Commentary• (h) an assessment of the adequacy of the

calculation of the insurer’s ICRC..;

• (i) an assessment of the suitability and adequacy of reinsurance arrangements, including the documentation of reinsurance arrangements …, and whether the reinsurance arrangements are sufficient to cover the Probable Maximum Loss defined in GPS 116



Catastrophe Risk• Models; Assumptions & Parameters

• Uncertainty

• Reinsurance Wordings

• Reinsurance Design



Models• Assumptions & Parameters

– Model inputs & mappings

– Dealing with missing values

– Underlying exposure projection



Models• Assumptions & Parameters

– Under-insurance

– Additional Loss Costs (removal of debris,

temp accom, hire car, etc)

– Demand surge



Models• Model Uncertainty

• Random error

• Unmodelled error



Uncertainty?

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0 100 200 300 400 500 600 700 800 900 1000

Lo

ss $

Bn

Return Period

Modelled OEP Curve



Unmodelled Aspects?• Earthquake examples seen

– Others?

• Cyclone– Asbestos contamination

– Coincident flooding

• Hail– 500,000 hail damaged cars?



ALAE• Additional Loss Adjustment Expenses

– Salaries of staff or fees for external parties working on event

– Mobilisation costs (flights, hire cars, meals)

– Staff equipment, especially where new people are brought in.

– Temporary (or not so temporary) site costs

– Advertising costs (eg site signage, assessment day ads)

– Legal costs

– Other event related costs…



ALAE• Can be large for major events

– Outside ‘business as usual’ operations

– Christchurch: reports of >10%

• Do catastrophe models include it?



ALAE in Aus Models• Vendor 1:“The Australian model does not include LAE explicitly

or implicitly. This means that the LAE has been

removed from the claims and the model has been

calibrated to the historic losses excluding LAE.”

• What should be added?



ALAE in Aus Models• Vendor 2:“In Australia they have used industry aggregate level losses to calibrate the model, hence the modelled losses will include LAE to “a certain extent” (i.e. figures between 1% to 4% depending on mix of losses) but not precise.”

• Should more be added?



ALAE Elsewhere• NZ

– Different again…

• Other countries

– Varies



Models with ALAE Added

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0 100 200 300 400 500 600 700 800 900 1000

Lo

ss $

Bn

Return Period

Modelled OEP Curve With ALAE



ALAE• Generally included in the Ultimate Net Loss (UNL)

claimable under a reinsurance treaty.

• Reinsurers allow for this in their pricing.

• Some markets this may be allowed for as a specific

% on top of claims payments.

• Can a gap exist between ALAE actual and

recovery?



Dive in to Wordings…• What does the UNL definition include?…the sum actually paid by the Reinsured in settlement of losses or liability after making deductions for all recoveries all salvages and all claims upon other reinsurances, whether collected or not, and shall include all adjustment expenses including costs of litigation, if any, and all other loss expenses of the Reinsured including those where the Reinsured engages its own Insurance Surveyors and Motor Vehicle Assessors (provided these do not exceed the usual cost of outside experts for similar services), arising from the settlement of claims other than the salaries of employees and office expenses of the Reinsured.”



Wording Coverage??• Salaries of staff or fees for external parties working on event

• Mobilisation costs

• Staff equipment

• Temporary site rental

• Legal costs

• Advertising costs

“…other than the salaries of employees and office expenses of

the Reinsured”

• Could the total retained event cost be greater than first

thought?



Additional Retained Losses• Where some but not all ALAE

can be recovered, the effective

retention will be the treaty

retention + unrecovered ALAE.

• When determining the ICRC it is

necessary to include ALAE.

• Whilst it may be assumed all

ALAE can be recovered, this

must be validated.

0

100

200

300

400

500

Claim

Payments Plus

ALAE

Cat Recovery Unrecovered

ALAE Plus

Retention

Total Retained

Loss

Example of Unrecovered ALAE$450m Claims Costs + $40m ALAE

Cat Retention $50m



Traditional Structure• 1-in-200 + a margin?

• How much margin?

• How many reinstatements at various

levels?



Traditional Structure• Cover + reinstatement

• May be some lower layers with more

reinstatements to address H3 & H4

• Drop down attachment?

• May also include aggregate protection



Traditional Structure Limit• ’Sleep Easy’?

• How much extra cover is enough?

• How much would an extra $250m

cover cost?

• Trade-off?



Traditional Structure• Example $1.6bn PML (with no sleep easy layer):

– $75m retention

– $125m xs $75m + 2 prepaid

– $200m xs $200m + 1 prepaid

– $400m xs $400m + 1 prepaid

– $400m xs $800m + 1 prepaid

– $400m xs $1200m + 1 prepaid

• Total cover $3.175bn

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0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0 100 200 300 400 500 600 700 800 900 1000

Lo

ss $

Bn

Return Period

Modelled OEP Curve With ALAE Traditional Limit



Traditional Structure• Would the limit be enough?

• Can’t access the reinstatements if the

limit runs out…

• Backup cover may be required

(expensive)



Alternative Structure• Cascading Tower

• Total capacity the same*

• More than double the vertical protection

• Essentially a giant aggregate (in layers)



Cascading Structure• Comparative Example:

– $75m retention

– $125m xs $75m

– $200m xs $200m

– $400m xs $400m

– $400m xs $800m

– $400m xs $1200m

– $1650m xs $1600m

• Total cover $3.175bn

• Layering shown here is for easy comparison to traditional

• Actual layering chosen would differ

• Note – NO reinstatements

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0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0 100 200 300 400 500 600 700 800 900 1,000

Lo

ss $

Bn

Return Period

Modelled OEP Curve With ALAE Cascading Limit



Limit vs Modelled Loss

0.0

0.5

1.0

1.5

2.0

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3.0

3.5

4.0

0 100 200 300 400 500 600 700 800 900 1000

Lo

ss $

Bn

Return Period

Modelled OEP Curve With ALAE Traditional Limit Cascading Limit



Cascading Structure• Losses from each event access higher up

the tower

• Single shot throughout tower

• Slightly higher price than same capacity in a traditional structure

• Backup covers are bought ‘at the top’ (cheap)



Cascading v Traditional• Loss Operation Example

– $30m, $50m, $320m, $600m

– Recovery under both $770m

– Backup costs would vary significantly



Cascading V Traditional• Cascading

• $320m Loss– $175m layer 1

– $120m layer 2


– $400m layer 3

– $45m layer 4

• Traditional


– $120m layer 2


– $200m layer 2

– $200m layer 3



Cascading V TraditionalLayer Limit Deductible

400,000,000

5XL Limit

~

1,200,000,000

4XL Limit 400,000,000

800,000,000

3XL Limit 400,000,000

400,000,000 200,000,000

2XL Limit 200,000,000

200,000,000 120,000,000 200,000,000

1XL Limit 125,000,000

######## 75,000,000 125,000,000 125,000,000

Retention 75,000,000 75,000,000 75,000,000

Tra

dit

ion

al

Layer Limit Deductible

6XL Limit 1,600,000,000

~

1,600,000,000

5XL Limit 400,000,000

~

1,200,000,000

4XL Limit 400,000,000

800,000,000 45,000,000

3XL Limit 400,000,000

400,000,000 400,000,000

2XL Limit 200,000,000

80,000,000

200,000,000 120,000,000

1XL Limit 125,000,000

75,000,000 125,000,000

Retention 75,000,000 75,000,000 75,000,000

Cas

cad

ing



Cascading V Traditional• Cascading

• Backup at top

– $770m xs $3250m

• Traditional

• Backup at bottom

– $125m xs $75m x2?

– $200m xs $200m x2?

– $200m xs $400m



Cascading v Traditional• Loss Operation Example

– Single $2bn event

• Recovery

– Traditional: $1.525bn ($475m retained)

– Cascading: $1.925bn ($75m retained)



Summary• The only thing certain about cat

modelling is that there MANY sources

of uncertainty – some quite significant.



Summary• Reinsurance wordings can also create

uncertainty

– Seek contract clarity

– In a big event, you don’t want to be

having an arm wrestle with your reinsurers.

You want to focus on helping customers.



Summary• Traditional structures with ’Sleep Easy’

– Really?!

• Cascading structure can box away

‘out the top’ risk almost entirely.



Summary• Cascading will cost a bit more than a

traditional structure… but how much

more depends on how much money is

being spent already on cover above

the 1-in-200 point.



FCR Commentary• (h) an assessment of the adequacy of the

calculation of the insurer’s ICRC..;

• (i) an assessment of the suitability and adequacy of reinsurance arrangements, including the documentation of reinsurance arrangements …, and whether the reinsurance arrangements are sufficient to cover the Probable Maximum Loss defined in GPS 116

Documents

This presentation has been prepared for the 2016 …...This presentation has been prepared for the 2016 General Insurance Seminar. The Institute Council wishes it to be understood