Strengthening FSA s Reinsurance Regulatory Capabilities: Eugene N. Gurenko Project Leader World Bank/FIRST

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1 Strengthening FSA s Reinsurance Regulatory Capabilities: Eugene N. Gurenko Project Leader World Bank/FIRST

2 Main objectives The project was launched in the early 2010 and had the following objectives: Enable FSA to apply risk-based principles to the supervision of companies net risk retentions arising from property catastrophe risk business Enable FSA to account for reinsurers credit risk (counterparty risk) in determining companies own net risk retentions Encourage market-wide improvements in the quality of internal risk management in insurance companies (including reinsurance, accumulations control and reserving) Pave the way for gradual introduction of risk-based supervision for other business lines

3 Point of departure Market survey carried out in revealed the following shortcoming of the Kazakh market: KZ insurance market is highly vulnerable to EQ risk Very few companies had CAT XL treaties Most companies had net cat risk retentions well in excess of their own surplus capital Credit quality of reinsurers used by many local companies was much to be desired Accumulation control procedures for cat risk was used only by one company Although there are cat risk models available from large reinsurance brokers they suffer from insufficient resolution and, due to the inherent conflict of interest, tend to underestimate the true companies risk exposures to catastrophe risk. Often companies use facultative treaties to cede even the smallest of the risks which results in cumbersome reinsurance programs that are difficult to track, report and understand for both companies and the regulator.

4 Global Seismic Hazard Map (GSHAP, 1999) Giardini, D. (1999) The Global Seismic Hazard Assessment Program (GSHAP) /1999 [A compendium of articles describing the GSHAP project. ]. Annall di Geofisica, 42, pp.

5 Project challenges Lack of adequate reporting of companies cat risk accumulations by different business lines, type of construction and locations. This has been neither produced internally nor required by FSA. Lack of adequate reporting of companies reinsurance activities while some data on reinsurance activities has been collected by FSA, it was impossible to make any meaningful conclusions about the adequacy of companies risk transfer at the portfolio level and the overall credit quality of reinsurance protection. Non-existent risk-based supervision tools for cat risk that could be used by the FSA to supervise companies reinsurance activities.

6 What have we accomplished? Collected market data on gross and net cat risk accumulations; Collected market data on companies reinsurance programs; Developed standard reporting for both risk exposures and reinsurance Developed Kazakhstan specific earthquake risk model and generated a set of random earthquake events that follow previous EQ patterns in the country. Developed country specific risk vulnerability curves. Developed a bespoke risk-based regulatory tool for the Kazakh catastrophe insurance risk for three different classes of business; 5 different classes of construction and for over 20 locations.

7 regulation roadmap (main regulatory steps) we are here! Phase 1 partial RBS model Phase 2 RBSM - full RBS model no requirements on maximum aggregate net retentions 1. Risk exposure based methodology, backed by risk modelling 2.internal models accepted by authority on case by case basis 1.full standard RBSM (SII approach), backed by WB complex modelling 2. internal models accepted by authority Wednesday, May 16, Wednesday, May 16,

8 what is partial RBS model? 1. methodology to assess aggregate catastrophe net risk retentions of an insurer on the basis of 1 /n years catastrophe event backed by 1.1. modeling (financed by the World Bank) 1 RBS methodology A simplified version of RBS: 2. compliance and 2.1. simple reporting requirements 2.2. compliance criteria IT tools: IT solutions supporting methodology & compliance 2 compliance partial RBS Wednesday, May 16, Wednesday, May 16, 2012

9 partial RBS what aims? a. b. proposed requirements general Regulate aggregate net retentions from catastrophe risk accumulations; impose / enhance reinsurance regulation with prudent requirements on RI quality aim (i) (ii) (iii) (iv) increase attention and control over all catastrophe risk products; reduce risks related to insurer's solvency problems; move towards risk based supervision model Achieve improvements in credit quality of sold insurance products Wednesday, May 16, Wednesday, May 16,

10 partial RBS methodology to assess insurer s maximum net aggregate retention level 1 Calculate country net aggregate PML for a 1/200 years event (for a given catastrophe peril) step formula how? 1 measure aggregate exposure in force for cities city total of catastrophe sums insured in the city with largest exposure (eg. capital) 2 calculate gross PML 'simple approach' max (city) (PML coeff * ) city PML coefficients to be generated by the model 3 accepted catastrophe reinsurance capacity amount of calculated PML ceded to reinsurance recognize only reinsurance capacity received from reinsurers rated BBB +or more. 4 calculate 'net aggregate PML' 2 minus 3 Wednesday, May 16, Wednesday, May 16, 2012

11 How will it work? FSA introduces (i) new reporting requirements for cat risk aggregates; (ii) sets a pre-specified risk management target by specifying the risk-return period to which companies should manage their risk aggregates, e.g. a 50-year event in 2011; 75- year in 2012: ; The data on risk exposures and reinsurance programs reported by companies will then be processed by an internal regulatory tool (supplied by WB) to calculate companies compliance with its solvency requirements. All net risk retentions (up to a risk return period specified by FSA) uncovered by either reinsurance or own capital will be netted against companies surplus capital and hence will have a direct impact on companies solvency. Insurers will be encouraged to develop and use their own internal catastrophe risk models to develop a view on their net catastrophe risk exposures prior to submitting the aforementioned data to FSA. In case of material differences in the results of the Solvency analysis carried out by FSA internal model and that of a company s internal risk model, the company will be given a chance to argue its case to FSA by presenting major parameters and assumptions underpinning the internal model. The FSA reserves the right to seek a third opinion on the company s internal model from a professional third party contractor. All costs related to the professional peer review of the company s internal model will be borne by the company.