P&C Cat modelling: reinsurer s standpoint

Transcription

1 P&C Cat modelling: reinsurer s standpoint Benoît Hugonin Director of Prudential affairs - SCOR Les innovations face au développement des catastrophes non-vie Tours, 19 March 2013

2 P&C Cat modelling: reinsurer s standpoint 1 Attitude when CAT risk materializes 2 Providing diversification 3 Beyond model limitations 4 Beyond the non modelled 2

3 2011 was a year characterized by record Cat losses, exceeding $100 billiion 1) for the insurance industry 2011 is the second most impacted year in terms of the frequency and level of nat cat losses Earthquake and tsunami in Japan Floods in Thailand Floods in Australia Earthquake in New Zealand 1) Source : AM Best report of 23 April

4 In this volatile environment, reinsurers have fully played their shockabsorbing role 1 Identifying uncertainties Anticipating and detecting early disruptions and discontinuities Interpreting the various positive and negative news flows Distinguishing potential adverse developments Expanding universe of shocks & ruptures Pandemic risks Solvency requirements Nat cat, climate change 2 Quantifying uncertainties Assessing the potential impact of shocks on assets and/or liabilities Using simulation models where necessary Solving the ambiguity dilemma: change in statistical distributions or specific draws from a given distribution? Regulatory & tax changes Protectionism menace 4 Absorbing shocks Respecting risk appetite and buffer capital Optimizing ILS and retrocession protection Enhancing financial flexibility Maximizing diversification New risks Accounting rules Financial disruptions 3 Preventing & hedging risks Using decision-making tools in uncertain environment models Evaluating various alternative hedging strategies Minimizing ex-post regrets Source: SCOR 4

5 Reinsurers reactions when CAT risk occurs After exceptional losses in 2011, some reinsurers have reconsidered their business models and have been retrenching 2 possible attitudes for reinsurers: Opportunistic approach Long-term commitment Benefits of long-term commitment: Providing capacity in tough times is an essential part of the value proposition of reinsurers over the long term Pulling out of a market after a big Cat event doesn t make sense. One event doesn t usually make another one more likely! 5

6 Strong franchise means constant innovation SCOR has deployed v1.0 of its Cat Platform Technology A joint development project with RMS, the Cat Platform: Streamlines portfolio accumulation processes and integrates in real-time with SCORs contract management system Uses simulated Year Loss Table methodology, providing more accurate modelling of reinstatements, aggregate terms and seasonality Is designed to accommodate SCOR s internally developed cat models and 3 rd party models in addition to RMS views, as such or in blended solutions SCOR supports new open-architecture cat modelling initiative SCOR is part of an industry initiative (OASIS) to develop an open-architecture cat modelling framework, which aims to: Support validation of the existing suite of vendor models by enabling access to alternative views of hazard / vulnerability models Facilitate the development of new models for territories that are not currently supported by the main vendors, with the Thailand Flood model an early candidate 6

7 P&C Cat modelling: reinsurer s standpoint 1 Attitude when CAT risk materializes 2 Providing diversification 3 Beyond model limitations 4 Beyond the non modelled 7

8 High diversification facilitates better management of cat risk Much has been said over the past few months against diversification: "de-diversifying "di-worse-ification diversi-fiction We believe in the virtues of diversification, be it: geographic diversification diversification across P&C lines of business diversification between Life and Non-Life 8

9 Cat risks no longer always occur in the same place In Biblical times, plagues kept on striking the same country (Egypt) again and again: Water turned into blood Frogs Lice Flies Livestock diseases Unhealable boils Hail and thunder Locusts Darkness Death of the first-born of all Egyptian humans and animals Today, natural disasters do not always hit the same region Source: Guy Carpenter,

10 Intro Internal Model Diversification Closing Remarks The risk / return couple: optimization of the P&C and Life business mix Diversification used for optimizing the return on risk taking Risk / return curve based on the Life / Non-Life business mix Rate of return Minimized Risk taking Life: ~50% of the business mix Optimized return on Risk taking Market line Life: 0% Sharpe ratio: Return per unit of risk Life: ~75% of the business mix Life: 100% of the business mix Risks (volatility of the portfolio) 10

11 Intro Internal Model Diversification Closing Remarks Diversification benefit: writing different CAT-lines (Gross figures) 30% 26,8% one-year capital 20% 10% 0% 19,5% 16,1% 14,1% 12,6% 12,5% 10,7% 7,2% 3,0% 3,8% 2,2% 0,3% 0,6% 1,4% CAT-line 1 CAT-line 2 CAT-line 3 CAT-line 4 CAT-line 5 CAT-line 6 CAT-line 7 Standalone Diversified one-year capital 100% 80% 60% 40% 20% 0% Sum of standalone one-year capital across CAT-lines 30.8% Sum of diversified one-year capital across CAT-lines CAT-line 7 CAT-line 6 CAT-line 5 CAT-line 4 CAT-line 3 CAT-line 2 CAT-line 1 Strong diversification benefits can already be realized by writing a portfolio of CAT-lines (different Peril / Region) 100% = sum of GROSS standalone one-year capital across all CAT lines 11

12 Intro Internal Model Diversification Closing Remarks Diversification benefit: writing different CAT-lines (Net figures) one-year capital 15% 10% 5% 0% 12,8% 10,7% 10,4% 7,8% 6,7% 5,6% 6,0% 6,4% 4,4% 3,8% 1,0% 0,3% 0,3% 0,7% CAT-line 1 CAT-line 2 CAT-line 3 CAT-line 4 CAT-line 5 CAT-line 6 CAT-line 7 Standalone Diversified one-year capital 100% 80% 60% 40% 20% 0% 59.7% Sum of standalone one-year capital across CAT-lines 17.3% Sum of diversified one-year capital across CAT-lines CAT-line 7 CAT-line 6 CAT-line 5 CAT-line 4 CAT-line 3 CAT-line 2 CAT-line 1 Apart from the direct benefit from Reinsurance / Retrocessions additional diversification benefit is achieved through re-balancing CAT-lines to similar volume and volatility. The Scale is still based on the sum of the GROSS Stand-alone Capital to show effect of the Retro Protection. 100% = sum of GROSS standalone one-year capital across all CAT lines 12

13 Intro Internal Model Diversification Closing Remarks Impact on modelled & non-modelled CAT lines 100,0% 90,0% 12,2% 80,0% 70,0% 42,2% 60,0% 50,0% 40,0% 30,0% 57,8% 87,8% CAT non-modelled CAT modelled 20,0% 10,0% 0,0% Sum of standalone one-year capital across CAT lines Sum of diversified one-year capital different CAT lines CAT tools while mature, are not yet comprehensive. Don t forget the «non-modelled»! 13

14 Intro Internal Model Diversification Closing Remarks Diversification benefit (Net). with other lines of business & reserves one-year capital 15% 10% 5% 0% 12,8% 10,4% 10,4% 7,8% 5,6% 6,0% 6,4% 4,2% 1,9% 2,1% 0,1% 0,8% 0,3% 0,6% CAT-line 1 CAT-line 2 CAT-line 3 CAT-line 4 CAT-line 5 CAT-line 6 CAT-line 7 Standalone Diversified one-year capital 80% 60% 40% 20% 59.7% 10.0% CAT-line 7 CAT-line 6 CAT-line 5 CAT-line 4 CAT-line 3 0% Sum of standalone one-year capital across CAT-lines Sum of diversified one-year capital across CAT-lines CAT-line 2 CAT-line 1 As expected material diversification benefits can be realized by additionally writing non CATlines. Scale is still based on GROSS for comparison to the two previous slides, showing the combined effect of Retro and diversification with other lines. 100% = sum of GROSS standalone one-year capital across all CAT lines Note, diversification is across CAT and non-cat lines, however, only the CAT-lines are displayed 14

15 Intro Internal Model Diversification Closing Remarks Diversification benefit: Illustration of the whole portfolio (Net) 60% 58,9% 50% 48,0% one-year capital 40% 30% 20% 41,1% 32,5% 20,2% 23,8% Standalone Diversified 13,7% 10% 0% 6,6% 8,8% 0,2% 5,8% 3,6% Current UY Reserves CAT-line 1 CAT-line 2 Line of Business 1 1,1% 0,7% Line of Business 2 Line of Business 3 Similarly, a global CAT portfolio aids in the diversification of the non-cat lines. Scale is now the NET Standalone Capital of the whole portfolio, including reserves 100% = Standalone NET one-year capital Current UY + standalone NET one-year capital Reserves 15

16 Intro Internal Model Diversification Closing Remarks How Diversification works: CAT-line 1 (Net figures) Worst 1% scenarios of Cat-line 1 (standalone), and Cat-Line 1 results in the worst 1% scenarios of the whole portfolio (diversified) counts of the realization within the ranges %-90% :-80% :-70% :-60% :-50% :-40% :-30% :-20% :-10% : : -90% -80% -70% -60% -50% -40% -30% -20% -10% 0% -100%= Most negative outcome for the company realized in the tail worst 1000 out of 100K realizations (1%) Negative outcome for the company 0% : 10% realization ranges 10% : 20% 20% : 30% 30% : 40% 40% : 50% 50% : 60% 60% : 70% Standalone Diversified 70% : 80% positive outcome for the company 80% : 90% 90% : 100% 100%= Most positive outcome for the company realized in the tail There are still many scenarios where the contribution from a single CAT-line is profitable in the worst economic cases that drive the capital of the Non-Life company 16

17 Intro Internal Model Diversification Closing Remarks Diversification benefit: drivers for different Lines of Business (Net figures) The drivers for & against diversification benefit are: size/volume, volatility of the sub-portfolio as well as dependence with the rest of the portfolio size of CAT-lines and LoBs is represented by the size of the spheres, respectively 17

18 Cautionary preliminary conclusions The rising risk of extreme events has much in common with playing with loaded dice. - Pew Centre Climate regimes: (El Nino, NAO, AMO) Climate change Inaccurate dependencies 2010 & 2011 record years for natural hazards Increasingly frequent medium-severe to severe insured losses caused in particular by localized natural catastrophes (tornadoes, wildfires, floods, hail storms, snow storms or frost) Non-modelled or badly modelled losses 18

19 P&C Cat modelling: reinsurer s standpoint 1 Attitude when CAT risk materializes 2 Providing diversification 3 Beyond model limitations 4 Beyond the non modelled 19

20 Intro Internal Model Diversification Closing Remarks Evolution of internal models Value Protection Value Sustainment Value Creation Collection of sub models quantifying parts of the risks Valuation Model 1 Valuation Model 2 Risk Model 1 Valuation Model 3 Risk Model 2 Market Risk 1960s s today Quantification of different risk types in a portfolio Financial Instruments Portfolio Data Credit Risk Insurance Risk Risk types are combined to arrive at the company s total risk in the tails Market Risk Financial Instruments Portfolio Data Internal Group Retro. Management Strategy Credit Risk Insurance Risk Total Risk Operational Risk Distributional and Dependency Assumptions Modelling of underlying risk drivers with full probability distributions Risk Factors Distributional and Dependency Assumptions Scenarios Valuation Engine Balance Sheet Profit and Loss Financial Instruments Portfolio Data Internal Group Retro. Management Strategy 20 20

21 Intro Internal Model Diversification Closing Remarks Dependencies - Data insufficient to reliably measure Domain of Risk Capital are the tail or extreme scenarios (the 1/100 years for example) Historical data cannot capture the dependency at these extreme events, and sole reliance on it can be misleading Reliance on expert assessments, via an unbiased and thorough mechanism that digs into the sources of dependencies, is good complement. Assessment focus on the extreme scenarios and their causes: [ X > VaR X ) Y VaR ( )] P > 0.99( Y X X+Y Y Suppose Y exceeds its 1-in-100 year threshold. What is the probability that also X exceeds its 1- in-100 year threshold? 21 21

22 Intro Internal Model Diversification Closing Remarks Calibration of P&C dependencies Inside LoB reading Risk drivers / Lines of Business Between LoBs Natural Catastrophe Man-Made Catastrophe Per Event Legal Change Political Instability Economics Coinsurance The table represents a visual summary of the risk drivers documentation arisen from PrObEX Model & parameter risks Agriculture Auto Aviation Credit & Surety Engineering Liability Marine Property (Non CAT) Space Workers Comp. Influence of risk drivers on LoB: high medium low 22

23 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A A couple of specific challenges to CAT (internal) models Key requirements for internal models: 1. Reliable expert judgment / choice of assumptions 2. Data quality (appropriate, complete and accurate) Additional challenges with CAT modelling 1. Use of external/vendor models 2. Rare events Insurers and reinsurers are usually in different positions to face those challenges 1. Expertise on peak reinsurers > insurers 2. Data more directly available to insurers > reinsurers Answers from a reinsurer 1. Robust documentation 2. Enhanced access to data through Cat Platform 23

24 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A What is a platform? Most importantly, a platform is not A piece of bolt-on software that is unnecessarily complex and weighty A silo software that you simply use for running a model and generating a report A platform can simply be defined as a place to launch application software and it may include some baseline hardware and software. A successful platform in the context of re/insurance should be an agile and scalable business ecosystem and have, amongst other features: A comprehensive toolkit that allows robust execution and reduction of model-ware clutter Be designed to go beyond the conventional limits of modelling by leveraging advances in analytic and technical computing capability Be able to drive out manual and repetitive processes that don t add value Create integration and automation points to other business workflows to aid decisions Improve risk quantification through risk intelligence (e.g. explore uncertainties /sensitivities) Allow generation of internal view of risk with interoperability, blending and calibration of multiple model sources SCOR s Platform initiatives include the Cat Platform and the Fac Platform. 24

25 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A The accidental cat modelling ecosystem Over the last 20 years or so... Cat models have become embedded within organisations and facilitate key functions : Cat pricing Portfolio management including post event response Inwards risk management and retro placement Calculation of capital adequacy Regulatory compliance and rating agency reporting Off-the-shelf cat models have provided incredible value by enabling: Improved Risk quantification of natural and man-made disasters Increased discipline across the entire risk transfer chain Ease of risk transfer through the currency of model outputs Robust risk management analytics Data creation to support the overall ERM process 25

26 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A The accidental cat modelling ecosystem The current challenges... Business leaders, regulators and practitioners are continuously raising the bar Conventional model packages are creating real operational challenges for businesses Analytical appetite of users are no longer being fulfilled, challenges around: Model performance/execution capability (behind what is needed and what is possible) Core financials are modelled well but more complex T&C s on the perimeter are often not Business requirements around data governance (reporting/downstream) are increasing across the entire risk transfer chain Models are generally fine ( although always evolving) for peak perils but not for secondary, non-peak and un-modelled perils Model inflexibility has forced companies develop suites of bespoke and complex model interfacing tools. These accidental modelling ecosystems have evolved over time but there are issues: Significant overhead to keep bespoke model-ware aligned High risk strategy and often this introduces key person risk Reached a saturation point where the value proposition is diminishing 26

27 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A Cat Platform An ambitious development project State-of-the-art comprehensive analytical framework... Platform capability to handle a reinsurers complex cat book including advanced analytics tools including: Cedant exposure analytics Cedant and portfolio modelling Dynamic portfolio risk aggregation an follow-up Portfolio management and optimization Real-time integration with other production systems: Contract management system Pricing Capital Model Increased operational efficiency by driving out manual processes Delivering interactive access and value to a broader internal audience beyond cat modelling team Phased development with releases timed to deliver business value in time 27

28 Observations and Trends Cat Platform Initiative Fac Platform Initiative Wrap-up and Q&A Cat Platform - Functional features overview 28 28

29 P&C Cat modelling: reinsurer s standpoint 1 Attitude when CAT risk materializes 2 Providing diversification 3 Beyond model limitations 4 Beyond the non modelled 29

30 Non-peak, non-modelled is no excuse for non-management 2011 Cat events were unusual: Regional pattern: Asia-Pacific skew Non-Peak: over 50% of insured costs Perils: Earthquakes/floods rather than wind Non-modelled: 28% of insured costs Thai floods Australian floods The lack of model can apply : to the event itself: Copenhagen floods to secondary perils: Japanese tsunami following earthquake to the consequences for insureds: CBI/Supply chain disruptions following Thai floods 30

31 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks 2011 : Annus Horribilis for Catastrophe Losses A record year: Impact on the industry / society: over $100bn insured losses; Economic losses: ~ $350bn Mortality: ~27,000 Unusual (?) peril-regional pattern Asia Pacific skew Earthquake / Flood dominated Non-Peak over 50% Everything apart from Tohoku, Irene Non-modelled $30bn (28%) Thai flood Australia flood Surprises Japan: Mag, Tsunami, Fukushima US: Tornadoes NZ: Frequency, aftershocks, liquefaction Thai/Japan: CBI / Supply Chain 31

32 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks against a backdrop of higher expectations Stakeholder needs: Regulatory Solvency II and equivalent Internal model, ORSA, Pillar III Ratings Agencies Cat Questionnaires/Surveys ERM Investors / Analysts Transparency, confidence Clients Capacity Price stability Continuity Management Effective controls Better information for strategic decision making Protect Balance Sheet and Earnings 32

33 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks An incomplete vendor modelled view of global cat risk Not available yet Flood models (primary hazard) Thailand, Australia, India, China, US, Brazil, Central Eastern Europe, Saudi Arabia 2ndry perils Tsunami everywhere Storm surge other than US, UK Fire-following earthquakes Hail, Bushfire Correlations between perils Large scale weather patterns El Nino/La Nina NAO, AMO Lines of business Non-property CBI / Supply Chain 33

34 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks Some ways to bridge the gaps to a comprehensive view TVaR contribution by Return Period Tracking exposure Availability Reliability 100% 90% 80% Model Pareto Confidentiality Complex contracts Extending the model framework Bolt on risk profiles 70% 60% 50% 40% 30% Tsunami, Fire-following earthquake Correlate non-, badly-modelled LoBs In-house models 20% 10% 0% Not easy, but sometimes necessary Simple models, leveraging 3 rd party research Pricing and capital analysis Coherence, consistency One internal model Scenarios thinking the unthinkable 34

35 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks An Oasis in the desert? New cat model initiative Plug and Play An open framework for cat modelling Prototype models under construction: UK Flood European Wind North Africa Earthquake Cascadia Tsunami 35

36 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks Some closing comments (1/2) Vendor cat models have served the industry well for 20 years, and will continue to for the next 20 but, material gaps remain. Insurers and reinsurers need more and better models, quicker than the big 3 can deliver The cat modelling eco-system needs to and will get bigger 36

37 Intro Blind Spots Closing Gaps Paradigm Shift Closing Remarks Some closing comments (2/2) But, risk that regulators somehow slow down that process of growth Delays with Solvency II Growing skepticism around the use of internal models for regulatory purposes, for the time being in the banking world: In surveying the failings of financial authorities, both here and abroad, one can certainly identify some specific characteristics of pre-crisis regulation that look today to have been significantly misguided, rather than the advances they were formerly thought to be. So, for example, regulators became prone to place too much confidence in the capacity of firms to measure and manage their risks. [ ] a supervisory approach, which relies on a more opaque, firm-specific process of watching over banks' own risk-management and compliance systems. [ ] standardized measures serve as a floor to guard against the potential for models-based capital measures to understate capital needs under some circumstances. They are also substantially less opaque than, for example, the advanced internal ratings-based approach of Basel II, and thus would provide more comparable measures that are also more amenable to international monitoring. Daniel Tarullo, member of the Board of Governors of the Fed, 22 Feb 2013 Growing skepticism around diversification benefits Joint Forum reports Insurance risk vs financial risk: not the same (in)dependence in stressed situations. 37