Risk Mitigation and the role of (re)insurance Michael Eberhardt, CFA < copyright name, company or Institute> This presentation has been prepared for the Actuaries Institute 2016 Managing Extreme Events (In an Uncertain World). 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.
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Extreme natural catastrophes A global phenomenon Climate change, concentration of assets and increased interdependence of industries will continue to increase severity of both economic and insured loss The impact on life and recovery process is significantly worse in developing and third world countries due to no or underinsurance Insurance determines legal rights for individuals, corporations and governments to access funds quickly and efficiently following a natural disaster event
The role of (re) insurance in mitigating extreme events Information function: Providing information about exposure through underwriting policy, price, terms and conditions Capital: Providing funds to individuals, organizations and governments quickly after the event in order to rebuild economic and social activities Risk Transfer : (Re)Insurers provide enhanced capacity, mitigate impact on capital / cash-flow, reduce peak exposure in geographical areas and collaborate with capital markets in order to provide effective risk transfer for individuals, (insurance) companies and governments Know How: Development of tailored products to specific needs Claims service: Claims assessment, providing expert opinion and indemnify effectively and fairly in line with policy conditions
A few selected examples and learnings Katrina (23.08 31.08.2016) Economic loss: USD 125bn (normalised loss USD 174bn) Insured loss > 80bn (Indexed to 2015) Thailand flood (July December 2011) Economic loss: 48bn USD or 13% of Thai GDP Insured Loss : 16bn (indexed to 2015) NZ Earthquakes (04.09.2010, 22.02.2011 and smaller events) Economic loss: 40bn* NZD and growing (20% of GDP) Insured Loss: 30* bn NZD and growing *own estimation compiled from different sources
Hurricane Katrina (USA) Drivers for higher cost Economic Demand surge led to higher claims inflation Coverage expansion (payment beyond the terms of the contract) Lack of expertise regarding resilience of buildings (respectively the lack of considering it in the underwriting process) led to higher vulnerability of buildings than expected Abandoned houses following the event led to deterioration of damage
Hurricane Katrina (USA) Learnings re risk mitigation Loss Prevention measurements were implemented Building codes Dam construction Cat models were adjusted in both frequency and severity and started to factor in additional losses after the cat event The requirement of multi-line accumulation control became evident Integration of RDS into risk management process
Hurricane Katrina (USA) Learnings re risk mitigation Impact on UW policy: Stronger focus on data and data quality to cater for differences in building and construction type, occupancy, height, area, etc. The importance of Business Continuity Management plans became evident Stronger focus on management of catastrophe risk by rating agencies
Thai Floods - Particularities No precedent in Thailand and only rudimentary modelling was done; Pricing included a relatively small cost for natural catastrophe events and reinsurance structures partially used per risk XL treaties to cater for catastrophe exposure (several event limits in per risk treaties) Unexpected accumulations and high impact of business interruption and contingent business interruption Lengthy period before losses were reported Various reinsurance programs were maxed out which led to financial distress of certain players Underinsurance was a major problem
Thai Floods Learnings re risk mitigation Expect the unexpected and think outside the box Definition of policy wordings (hours clause) Focus on interdependencies & correlation in risk management Difficulties regarding claims process in developing countries
New Zealand Earthquakes - Particularities The impact of liquefaction was underestimated Difficulties in processing the high number of claims Lack of claims professionals as well as engineering expertise when it comes to assessment of structural damages Challenges in allocating claims to individual events Separation of claims handling between EQC and insurers (EQC handles residential claims up to 100,000 NZD and insurer above) led to late reporting of claims Rebuilding cost due to full replacement policies significantly increased costs compared to pre-eq assumptions Most insurance companies including EQC ran out of cover
New Zealand - Learnings re risk mitigation Open replacement policies have converged to Sum Insured policies for most part of the market Structural reform discussions around the role of EQC High insurance penetration rate allowed the NZ economy to continue to grow since the devastating earthquakes occurred in 2010 and 2011 and to moderate impact on debt / GDP
Commonalities between the events The severity potential of the three events was underestimated, the reinsurance limits of several cat XL programs were exhausted All events led to bankruptcies of corporations, insurance companies and reinsurers exiting the market as well as upwards adjustments of cat models Non-modelled perils significantly contributed to loss cost (payments above sum insured, demand surge inflation, BI and CBI, liquefaction in combination with full replacement policies ) Each event triggered changes to UW policy, risk management considerations and often political involvement The public picture of the insurance industry following the events has been negative despite of billions in payout insurers are seldom the darling New entrants followed substituting or increasing capacity from exits
RI Risk Mitigation Tools Reinsurance Capital Markets Cat Excess of Loss Cat Aggregate XoL Quota Share Structured reinsurance Facultative Reinsurance ILS Cat Bonds External Financing (Equity/ Hybrid) Protection against Severity Frequency Protection Proportional Risk Sharing (event limit to be factored in) Spread of risk over time Managing peak exposures and risk sharing of individual risks Using the capital market to increase capacity Capital Enhancement
Conclusion The insurance and reinsurance industry is pivotal in mitigating extreme events due to: Know-How in assessing, evaluating and pricing catastrophe risk Claims management capabilities Addressing underinsurance and developing new products (CCRIF, African Risk Capacity) Allocating funds effectively and efficiently to persons /corporates and organizations Risk mitigation for extreme events starts PRIOR to the catastrophe by identification of risk measurement and quantification of risk applying various techniques Creating awareness Buying the appropriate product and the appropriate level of (re)insurance