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

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2 Catastrophe Model Assumptions, Uncertainty And Reinsurance Structure Response Charles Pollack

3 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

4 Catastrophe Risk Models; Assumptions & Parameters Uncertainty Reinsurance Wordings Reinsurance Design

5 Models Assumptions & Parameters Model inputs & mappings Dealing with missing values Underlying exposure projection

6 Models Assumptions & Parameters Under-insurance Additional Loss Costs (removal of debris, temp accom, hire car, etc) Demand surge

7 Model Uncertainty Random error Unmodelled error Models

8 Loss $Bn Uncertainty? Modelled OEP Curve Return Period

9 Unmodelled Aspects? Earthquake examples seen Others? Cyclone Asbestos contamination Coincident flooding Hail 500,000 hail damaged cars?

10 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

11 ALAE Can be large for major events Outside business as usual operations Christchurch: reports of >10% Do catastrophe models include it?

12 Vendor 1: ALAE in Aus Models 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?

13 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?

14 NZ ALAE Elsewhere Different again Other countries Varies

15 Loss $Bn Models with ALAE Added Modelled OEP Curve Return Period With ALAE

16 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?

17 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.

18 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?

19 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 Example of Unrecovered ALAE $450m Claims Costs + $40m ALAE Cat Retention $50m Claim Cat Recovery Payments Plus ALAE Unrecovered ALAE Plus Retention Total Retained Loss

20 Traditional Structure 1-in a margin? How much margin? How many reinstatements at various levels?

21 Traditional Structure Cover + reinstatement May be some lower layers with more reinstatements to address H3 & H4 Drop down attachment? May also include aggregate protection

22 Traditional Structure Limit Sleep Easy? How much extra cover is enough? How much would an extra $250m cover cost? Trade-off?

23 Loss $Bn 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 Return Period Modelled OEP Curve With ALAE Traditional Limit

24 Traditional Structure Would the limit be enough? Can t access the reinstatements if the limit runs out Backup cover may be required (expensive)

25 Alternative Structure Cascading Tower Total capacity the same* More than double the vertical protection Essentially a giant aggregate (in layers)

26 Loss $Bn 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 ,000 Return Period Modelled OEP Curve With ALAE Cascading Limit

27 Loss $Bn Limit vs Modelled Loss Return Period Modelled OEP Curve With ALAE Traditional Limit Cascading Limit

28 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)

29 Cascading v Traditional Loss Operation Example $30m, $50m, $320m, $600m Recovery under both $770m Backup costs would vary significantly

30 Cascading V Traditional Cascading $320m Loss $175m layer 1 $120m layer 2 $600m Loss $80m layer 2 $400m layer 3 $45m layer 4 Traditional $320m Loss $175m layer 1 $120m layer 2 $600m Loss $125m layer 1 $200m layer 2 $200m layer 3

31 Traditional Cascading Cascading V Traditional Layer Limit 6XL Limit 1,600,000,000 Deductible 5XL Limit 400,000,000 1,600,000,000 ~ 5XL Limit Layer Limit 400,000,000 Deductible ~ ~ 4XL Limit 400,000,000 1,200,000,000 4XL Limit 400,000,000 1,200,000,000 3XL Limit 400,000, ,000,000 45,000,000 3XL Limit 400,000, ,000,000 2XL Limit 200,000, ,000, ,000,000 80,000,000 2XL Limit 200,000, ,000, ,000,000 1XL Limit 125,000, ,000, ,000,000 75,000, ,000, ,000, ,000, ,000,000 1XL Limit 125,000,000 ######## 75,000, ,000, ,000,000 Retention 75,000,000 75,000,000 75,000,000 Retention 75,000,000 75,000,000 75,000,000

32 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

33 Cascading v Traditional Loss Operation Example Single $2bn event Recovery Traditional: $1.525bn ($475m retained) Cascading: $1.925bn ($75m retained)

34 Summary The only thing certain about cat modelling is that there MANY sources of uncertainty some quite significant.

35 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.

36 Summary Traditional structures with Sleep Easy Really?! Cascading structure can box away out the top risk almost entirely.

37 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.

38 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