© 2013 Finity Consulting Pty Limited

Catastrophe Models:

A non cat-modeller’s

perspective

Prepared by Tim Andrews | May 2014

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Nine quotes from a Catastrophe Modelling Conference earlier this year

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“Boards don’t understand what a return period is”

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1 in

Source: Stirling et al, 2012

A paradox

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How can a 1 in 400 year event occur every 50 years?

Does a diversified insurer need to allow for a more severe catastrophe than an insurer concentrated in one location?

Single State Insurer – Single Peril

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$300m

1 in 200

Two State Insurer – Single Peril

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$300m

$300m

1 in 200

1 in 200

$300m event every 100 years for the portfolio

Multi State Multi Peril

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$300m

$200m

$400m

$300m

$500m

$200m

$500m

$400m$300m

- 1 of these 1 in 400 year events every 44 years!- $700m event every 200 years for portfolio

Single State vs Multi State

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PML equivalent to worst1 in 200 year event$200m

PML equivalent to worst1 in 200 year event for portfolio$700m

Single State Insurer Multi State Insurer

An insurer’s modelled cats

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Event Frequency Cost Location Description

A 0.00000042 $1,350m WA, Yilgam E/Q 7.1

B 0.00000038 $1,350m Northern New England

E/Q 6.8

C 0.00000000 $1,348m NW Victoria E/Q 7.2

D 0.00000513 $1,346m Perth Basin E/Q 6.5

E 0.00000774 $1,342m Nth Qld Cat 5 Cyclone

F 0.00000775 $1,342m NT Cat 5 Cyclone

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“Why aren’t the regulators here to listen to this?”

Some onerous guidance

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“……an insurer to be able to articulate its view on overall probability of sufficiency with respect to model outputs…….”

Really?!

“More generally, boards and senior management of insurers should satisfy themselves that the policies and practices they follow for catastrophe risk management are sound and lead to appropriately prudent outcomes. Each insurer should ensure that it: • clearly sets and articulates its appetite for

catastrophe risk; • understands the strengths, weaknesses

and inherent assumptions of any models it uses; “

Some insurer responses

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Clarify who has responsibility for assessing the PML

Implement clear framework, and process for oversight

More communication with cat modellers

Better documentation

More education

Possible roles of stakeholders

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Catastrophe modellers

Running models

Assessment of models

Sensitivities

Realistic Disaster

Scenarios

Reinsurance Manager

Improving data quality

Dialogue with modellers

Assess gaps in modelling

Design of reinsurance

arrangements

CFO, Actuary, CRO

Develop decision making

framework

Consistency with capital targets, risk

appetite

Consideration of key risks,

allowance for uncertainty

Set RDSs

CEO

Agree framework

Implement oversight process

Recommend PML and RI

Board

Set risk appetite

Agree framework

Oversight

Approve PML and RI

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“The models are being ‘opened up’ and this will enable better

understanding and will impact insurer decision making”

Understanding what is modelled

16 Source: GNS

Hazard - Seismic risk Response - Ground shaking (RMS Paper)

Damage - Damage Ratios

Types of questions that an insurer may

seek answers to

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What model are we using and why?

How does it compare to other models?

What are the key assumptions in the model?

How does the seismic assessment compare to Geoscience Australia’s current view?

What would be the impact of using alternative views of ground shaking?

How was the damage ratio calibrated?

What did we learn from Christchurch about the damage ratio?

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“If I was an insurer my main focus would be on ensuring our data is as

good as we can get it”

What insurer data is important?

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For each location (vs each policy)

Location of risk

Construction details

Age of property

Exposure ANZSIC

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“APRA keep asking us about our model for non-modelled perils”

A framework that considers non-modelled

hazards and perils

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Modelled PML

Explicit allowance for non modelled:

Hazards Costs

e.g. Fire following earthquake

e.g. Loss Adjustment Expenses

Are these modelled?

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Hazards

“Ultra-liquefaction”

Landslide

Fire following

Sprinkler leakage

Tsunami

Costs

LAE

BI

Fences, driveways

Temporary accom

Legal

Post loss amplification

Loss of rent (tenanted)

Infrastructure

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“Its hard to know what to do about unknown unknowns, or

known unknowns for that matter”

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“The Board wants to know if we have identified 85% of the risk, or

25%. What is the order of magnitude?”

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“We are uncertain about how to deal with the uncertainty”

Approaches for dealing with uncertainty

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Make no adjustment

Blending the results of various catastrophe models

Adopt a higher return period

Add a judgemental margin

Add explicit margin tied to the assessment of uncertainty

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“An RDS is a better way of gaining Board understanding”

Lloyds RDS for Japan Quake

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“Managing agents should consider all other lines of business that would be affected by the event. Particular consideration should be given to losses arising from: 1) Personal Accident - it should be assumed that 2,000 deaths and 20,000 injuries will arise as a result of this major earthquake. Assume that 50% of those injured will have PA cover……..”

Issues a Board may consider

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Linked to oversight

How did we assess how good our data is? Do we have a process for dealing with shortcomings?

How did we assess different models?

How did we assess what perils are not modelled?

How does the level of protection compare to our competitors?

How should we allow for uncertainty?

As evidence of process

What model are we using and why?

What allowance is made for growth?

What costs are not allowed for by the models?

Did we prepare RDSs? What did we learn from them?

Final thoughts on cat models

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Yes there is a lot of uncertainty

The models are a good place to start, but not the end point

We have learned a lot in recent years

Keep asking questions, but don’t expect them all to be answered (yet)

Diversified insurers have an advantage

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An update on the weather

What I said at a previous FSAA conference

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Impact of climate change on insurance costs in Australia to date minor

Variability in costs linked to natural cycles

Climate change will impact insurance costs, but gradual and over many years

Main areas of increase flood and bushfire

Impacts will vary by region

0

1,000

2,000

3,000

4,000

5,000

6,000

Norm

alis

ed C

laim

s C

osts

$m

Normalised Australian Natural Disaster Claims Costs

Source: Risk Frontiers/ICA

Feeling a little hot?

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Sea levels do vary

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18,000 years ago sea levels were 110 metres lower

During the previous intergalacial period (120,000 years ago) sea levels were 6m higher than current

How has our view changed?

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Not much

Bushfire risk has probably increased already

Regional impacts are greater than I had appreciated

Actions of the sea to be the biggest issue. Will make the current flood problems look minor

2014/15 forecast to be a strong El Nino. Is ENSO variability changing?

Increase in Bushfire Risk

Super El Nino in 2014/15?

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El Niño likely in 2014The El Niño–Southern Oscillation (ENSO) Tracker status is at El Niño ALERT level, meaning that there is at least a 70% chance of an El Niño occurring in 2014. Current observations and model guidance indicate an El Niño is likely to develop by spring, with some models indicating a transition to El Niño as early as July.

Source: BoM

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This presentation has been prepared for the

FSAA conference held on 19 May 2014. It

is not intended, nor necessarily suitable, for

any other purpose.

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