2010 AA Systemic and Catastrophe Risk

Systemic and Catastrophic Risk Are we hanging by a thread or securely tethered? David Alexander, Swiss Re ASHK Appointed...

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Systemic and Catastrophic Risk Are we hanging by a thread or securely tethered? David Alexander, Swiss Re ASHK Appointed Actuaries Symposium Symposium, November 2010

Agenda  Insurers' contributions to systemic risk in our financial systems  Systemic and catastrophe risk in the insurance industry  Risks  Mitigants  Conclusions

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Crisis hit insurers much less than banks Cumulative credit26% losses from 2007 2’000

USD bn

USD 1’715 BN 1’500

1’000 1 000

Cumulative credit losses from 2007, as % of 2006 Shareholders Equity 80%

60%

x6

40%

500

68%

x 2.6 26%

20%

USD 271 BN 0

0%

Insurers

Banks

Insurers

Banks

Source: Geneva Association Systemic Risk Report 2010 based on Marsh EMEA Insurance Reports 2007, 2008 and 2009, Bloomberg (as at 10 February 2010), DataStream, Oliver Wyman analysis

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The iinsurance and Th d reinsurance i iindustries d i weathered the financial crisis fairly well 

Business was conducted as usual: cover was always provided both in insurance and reinsurance, and claims were paid as usual throughout the crisis. i i



Prices and capacity remained stable in most lines of business.



There was no experience Th i off ““runs on iinsurers”” and d llapse rates iin lif life insurance remained stable.



Most capital was lost on assets, but (re)insurers remained solvent throughout the crisis



Problems were with monoline insurers involved in credit business and (re)insurers with FS operations



Very few insurers needed government support – and the support needed was minimal compared with banks

Approach for assessing systemic relevance of risk activities) Criteria considered for assessing the systemic relevance of risk activity

Risk activities 

Transmission mechanisms Transmission mechanisms

Specific considerations when assessing the criteria •D Does a transmission t i i mechanism h i exist? i t? • What are the triggers? • What is the likelihood of these triggers being breached? • Can the risk activity cause significant losses? • Can the activity be substituted by someone else? • How big is a potential impact?

Size/Impact

Speed

Systemically  relevant risk  activities activities 

• How fast does the loss materialise? • How fast does the loss transmit?

Risk activities are deemed systemically relevant if they pass the risk assessment

5 Source: Oliver Wyman analysis

Timing of transmission between insurers is slower than between banks Timing of World Trade Centre Insurance Claims Cumulative proportion of claims made

% of to otal net claims paid

100% 80% 60% 40% 20%

Quarters after 11 Sept 2001 Quarters after 11 Sept 2001

Gradual cash flows S Source: R Reinsurance i A Association i i off America, A i C Catastrophe h L Loss D Development l S Study d

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Q2 2008

Q4 2007

Q2 2007

Q4 2006

Q2 2006

Q4 2005

Q2 2005

Q4 2004

Q2 2004

Q4 2003

Q2 2003

Q4 2002

Q2 2002

Q4 2001

0%

Insurers core Insurers’ core-activities activities are not systemically relevant Risk activities not deemed systemically relevant A t Liability Li bilit M Managementt A o Asset

& Strategic Asset Allocation

o Underwriting catastrophe risks i k B o Underwriting long term risks o Writing business with redemption p options p o Writing life business with embedded guarantees o Hedging with derivatives o Reinsurance and retrocession C o Insurance linked securities and derivatives

D o Long-term capital raising E o Credit insurance

Systemic relevance rejected for at least one of the following reasons

   

Size: Limited size o No disruptive effects on financial markets Interconnectedness o Level / intensity of interaction g does not create contagion Substitutability o Given ability of market to find a substitute Timing: Slow speed of impact o Allows insurers to absorb impact, through capital raising or orderly wind-up

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In conclusion…

!

Size needs to distinguish between absolute concentration of exposure or dilution of risk through diversification

!

Interconnectedness needs to allow for the materiality of the connections compared to the overall balance sheet

!

Substitutability needs to distinguish between the uniqueness of any individual market participant, and the ability of a market as a whole to be re-capitalised

!

Timing of transmission between insurers is significantly slower than between banks, allowing mitigation measures that dampen systemic risk

Thus, we argue that the criteria need to be considered against specific risk activities, rather than institutions 8

Agenda  Insurers' contributions to systemic risk in our financial systems  Systemic and catastrophe risk in the insurance industry  Risks  Mitigants  Conclusions

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Significant risk is all around us

Pollution – environmental and health risks

Euthanasia – Acceleration of Claims Payouts

M k t Risk Market Ri k

Terrorism

N t lC Natural Catastrophe t t h

P d i Pandemic

Advancements in Medical Technology – Cost per Intervention

Asbestosis

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Naturall C N Catastrophe h Large Loss Potential E h Earthquake k

T i l Cyclone Tropical C l Extra tropical Cyclone Flood

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Insured Nat Cat vs. vs man man-made made losses 1970–2009 2005: Hurricanes Katrina, Rita, Wilma

USD bn, at 2009 prices

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• Increasing values

• Concentration C i iin exposed d areas

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• Insurance penetration

1992: Hurricane Andrew

g g hazard • Changing

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2004: Hurricanes Ivan, Charley Charley, 1999: Frances Winter storm Lothar

2008: Hurricanes Ike, Gustav

- climate variability - climate change

1994: Northridge EQ

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2001: Attack on WTC

10 0 1970

1975

1980

Earthquake/tsunami

1985

1990

1995

Weather-related Nat Cats

2000

2005

Man-made disasters Source: Swiss Re, sigma No 1/2010, Figure 3

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The most costly Th l iinsurance llosses in 2009 Insured loss 1 (in USD m)

1 2

Victims

2

Date (start)

Event

Country

3 372

25

24.01.2009 Winter storm Klaus, winds up to 170 km/h, heavy rain France, Spain

1 350

15

10.02.2009 Thunderstorms, winds up to 145 km/h, hail

US

1 193

11

23.07.2009 Hail storm Wolfgang, winds up to 130 km/h

Switzerland, Austria, Poland et al

1 130

2

09.04.2009 Tornadoes, storms, winds up to 105 km/h, hail

US

1 079

173

07.02.2009 Victorian bush fires, winds up to 100 km/h

Australia

1 050

1

10.06.2009 Thunderstorms, winds up to 128 km/h

US

995

6

25.03.2009 Thunderstorms with hail

US

800

-

20.07.2009 Storms, heavy rain, hail

US

760

2

26.05.2009 Hail storm Felix, winds up p to 90 km/h

France, Germany, y Belgium g

615

5

08.10.2009 Typhoon Melor/No 18, winds up to 204 km/h

Japan

570

-

07.05.2009 Storms, thunderstorms, winds up to 145 km/h; floods

US

Property and business interruption, excluding liability and insurance losses D d and Dead d missing i i

Source: Swiss Re, sigma No 2/2010 table 8

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Cat Risk - Natural Perils across Asia

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Hazard H dM Modelling d lli : 4 Box Principle

Natural Hazard

Example H icane Hurricane “Charley” Aug 2004

Vulnerability

Ocean Drive Drive, FL FL, 1926

What can happen?

How do the exposed values react? Ocean Drive, FL, 2000

Distribution Di ib i off property values

Insurance conditions

What is affected?

Limit

Deductible

How is the exposure covered? 15

Case study Caribbean: C ibb Caribbean C Catastrophe h Ri Risk k Insurance Facility (CCRIF) Solution features  The CCRIF offers parametric hurricane and earthquake insurance policies to 16 CARICOM governments  The policies provide immediate liquidity to participating governments when affected by events with a probability of 1 in 15 years or over  Member governments choose how much coverage they need up to an aggregate limit of USD100 million  The mechanism will be triggered by the intensity of the event (e.g. (e g winds exceeding a certain speed) speed).  The facility responded to events and made payments: – Dominica & St. Lucia after earthquake (2007) – Turks & Caicos after Hurricane Ike (2008) – Haiti (2010) Involved parties  Reinsurers: Swiss Re and other overseas reinsurers  Reinsurance program placed by Aon Benfield Ltd.  Derivative placed by World Bank Treasury

Background information  Caribbean states are highly susceptible to natural disasters and h have only l li limited i d options i available il bl to respond. With small economies and high debt levels, they often depend on donors to finance post-disaster needs, but do bu donor o resources esou ces o often e a arrive e late ae or not at all  The CCRIF was launched in June 2007 on behalf of the Caribbean Community (CARICOM) heads of government under the guidance of the World Bank with financial support from international donors  CCRIF participating governments are: Anguilla, Antigua & Barbuda, Bahamas, Barbados, Belize, Bermuda, Cayman Islands, Dominica, Grenada, Haiti, Jamaica, St Kitts & Nevis, St Lucia, St Vincent & the Grenadines, Trinidad & Tobago, Turks and Caicos Islands

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CCRIF - Present structure The CCRIF is the first multi-country risk pool in the world, and is also the first insurance instrument to successfully develop parametric policies backed by both traditional and capital markets.

Currency: USD

90m

 Losses of up to USD 12.5m is retained by CCRIF.  USD 132.5m is paid by the reinsurance contributed by the international reinsurers -

Reinsurance

132.5m

Cat Swap

 Next USD 30m of losses are reinsured with reinsurance companies.

30m

12.5m 12.5m

 First, USD 12.5m of losses are reinsured with reinsurance companies. companies

R i Reinsurance

 Two- third of the top p layer y i.e. USD 60m is paid p byy reinsurance companies,

Reinsurance

 USD 30m (i.e. one-third) in the top layer of risk is placed into capital market via a catastrophe swap between CCRIF and the World Bank Bank.

CCRIF Source: CCRIF Annual Report 2008-09 2008 09

 The group retains all the losses above USD 145m.  CCRIF is backed by donor funds held by the World Bank as a Multi-Donor Multi Donor Trust Fund. Fund 17

Nat Cat underwriting – key take aways 

Be mindful of loss accumulation potential due to natural catastrophe.



Come up with MPL scenarios. scenarios Control your exposure or buy adequate protection.



Use site specific risks factors to identify best risks from Nat Cat perspective



Identify and price for Nat Cat risks.



Introduce Nat Cat specific deductibles/sublimits in your policies. Extremely important for low frequency perils in any market

Financial Fi i l and dM Market k Ri Risk k 10-year Bond Yield History 

Hong Kong



Japan

8.22% 10.177%

0.901%

2.091%

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Interest rates STILL on the way down! ASIAN MARKETS COUNTRY

5YR GOVT YIELD LAST CLOSE

10YR GOVT YIELD YTD Δ (%)

LAST CLOSE

YTD Δ (%)

Taiwan

0.88

-13.51

1.22

-21.12

Hong Kong

1.12

-41.78

2.07

-19.66

Singapore

0 86 0.86

-32 32.81 81

2 00 2.00

-24 24.81 81

Vietnam

10.44

-10.67

11.03

-3.65

Malaysia

3.32

-12.40

3.81

-10.35

South Korea

3.75

-23.78

4.18

-22.45

Thailand

2.51

-30.83

2.98

-28.75

Indonesia

6.43

-28.34

7.16

-28.85

Philippines

5.11

-19.64

5.94

-26.74

India Australia

7.79 7 79 4.99

7.32 7 32 -3.49

8.14 8 14 5.16

7.26 7 26 -8.65

New Zealand

4.38

-20.15

5.10

-12.27

China

3.03

1.34

3.66

0.55

Japan

0.30

-37.00

0.90

-30.73

as of 22 Oct 10

Source: Bloomberg 20

Financial Market Issues 

Falling interest rates cause significant strains on life companies – Matching is not perfect – Liabilities often long



Equity and bond market falls can deplete solvency capital and force more capital to be held – there are trade offs and compromises between regulatory and economic focus



Inability to raise capital may hamper growth for some products



Cost of guarantees is higher



Furthermore, poor economics can be linked to – poor claims eg disability, mortality (suicide) – higher lapsation as customers adjust their finances 21

Pandemics – are you ready?

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Influenza pandemics can cause one-time one time mortality shocks 

Mortality has generally been improving for many decades



But life insurers still face the risk that an influenza p pandemic could cause a one-time mortality shock



Pandemics are infrequent and unpredictable



It is not easy to specify in advance the loss value from such an event …



… and therefore the amount of capital to hold



This makes it difficult for life insurers to quantify the risk and to manage p efficientlyy their capital



At the same time… – regulatory regimes are forcing insurers to consider this threat – there is a heightened general awareness of pandemic in the population – capital p markets are becoming g more aware of mortalityy risk

H5N1 was a near miss Emergence of a new virus sub-type

Global population has little or no immunity

New virus is capable of replication in humans and causes serious illness

New virus is capable of efficient human-to-human transmission

H5N1

   x

Emerging and re-emerging infectious diseases

Influenza A H1N1

A Assess the h exposure Insurance penetration i 2008 14%

Real premium growth Emerging Asia Life

2009 6.7%

Non-life

Non-life p premiums, 2008 (USD10 bn)

Taiwan

12%

Life premiums, 2008 (USD10 bn)

10% Hong Kong

Japan

8%

14.2%

South Korea

6%

Singapore

Australia Australia

4%

J Japan

2% 0%

S Korea

Taiwan

Singapore

Malaysia Thailand

India Vietnam

Indonesia Philippines

-2% -10%

Malaysia

0%

Average life penetration India China

Average non-life penetration Vietnam

China

Indonesia Philippines

Hong Kong

Thailand

10%

20%

30%

40%

Average real premium growth (1999 (1999-2008) 2008) Sources: Oxford Economics, Swiss Re Economic Research & Consulting.

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Modern p pandemic with characteristics of the 1918 influenza



The graph shows the cumulative effect ff on mortality rates of selected changes between 1918 (the “Base”) Base ) and 2006

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Sensitivity of outcome to plausible changes h iin variables i bl 1 of 2

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Sensitivity of outcome to plausible changes h iin variables i bl 2 of 2

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Agenda  Insurers' contributions to systemic risk in our financial systems  Systemic and catastrophe risk in the insurance industry  Risks  Mitigants  Conclusions

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Mitigants •Asset and Liability Management Enhancing capital position to make insolvency less likely – •Enhancing consider reinsurance as an efficient source of such capital •Adjusting Adjusting dividend policy – dividends for both policyholders and shareholders •Writing g business with less risk or diversifying y g risk eg g investment linked products and protection products •Product Design & Surrender value Policy •Hedging and Reinsuring excess risks to counterparties or capital markets

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Insurance regulatory developments in Asia means our exposure will ill become b more transparent Higher minimum capital requirements Adoption Low minimum of RBC and solvencyAdoption of RBC solvency systems solvency capital p systems t requirements in the past. Introduction of dynamic stress Higher tests and the use of scenarios statutory requirement push capital to Increased focus on consumer protection (eg the forefront forefront, policyholder post GFC. protection funds) Rating capital ((usuallyy higher) g ) will become Alignment of accounting standards to IFRS more important.



Regulatory uncertainty still high



Consolidation to accelerate in some markets



A driver of M&As



Impact on insurance portfolio as well as on asset management



Increase demand for reinsurance



Regional harmonisation

Conclusions 

Like it or not our companies are exposed to significant catastrophic risks



We are g getting g better at p perceiving g and mitigating g g that risk…



…but are we yet good enough… – for our policyholders? – for our shareholders? – for our own high standards?

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Thank you

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