logo image
More Topics

Reset Filters

EDITOR
link
March 17, 2017
What One Thing Would Help Close The Protection Gap?

In each edition of EXPOSURE, we ask three experts their opinion on how they would tackle a major risk and insurance challenge. This issue, we consider the protection gap, which can be defined as the gap between insured and economic losses in a particular region and/or type of exposure. As our experts John Seo, Kate Stillwell and Evan Glassman note, protection gaps are not just isolated to the developing world or catastrophe classes of business. John Seo Co-founder and managing principal of Fermat Capital The protection gap is often created by the terms of the existing insurance itself, and hence, it could be closed by designing new, parametric products. Flood risk is excluded or sub-limited severely in traditional insurance coverage, for instance. So the insurance industry says “we cover flood”, but they don’t cover it adequately and are heavily guarded in the way they cover it. A great example in the public domain was in 2015 in the Southern District Court of New York with New York University (NYU) versus FM Global. NYU filed a claim for $1.45 billion in losses from Hurricane Sandy to FM Global and FM Global paid $40 million. FM Global’s contention was that it was a flood clause in NYU’s coverage that was triggered, and because it was a flood event in essence their coverage was limited to $40 million. Ten to 20 years down the line… we might find that we’re actually naked on cyber Ostensibly on the surface NYU had $1.85 billion in coverage, but when it came to a flood event they really only had $40 million. So the protection gap is not just because there’s absolutely no insurance coverage for these types of perils and risks in these geographies and locations, but because the terms of protection are severely sub-limited. And I would claim that’s the case for cyber risk for sure. The industry is very enthusiastic about its growth, but I can see, 10 to 20 years down the line, with a significant national event on cyber that we might find that we’re actually naked on cyber, as NYU discovered with Sandy. You could have a Fortune 50 company in the U.S. thinking they have $1 billion of cyber coverage, and they’re going to have an event that threatens their existence… but they’ll get a check for $50 million in the post. Kate Stillwell Founder and CEO of Jumpstart Recovery My absolute fundamental goal is to get twice as many people covered for earthquake in California. That doesn’t mean they’re going to have the same kind of earthquake insurance product that’s available now. What they will have is a  product which doesn’t fill the whole gap but does achieve the goal of immediate economic stimulus, and that creates a virtuous circle that gets other investment coming in. I wouldn’t have founded Jumpstart if I didn’t believe that a lump-sum earthquake-triggered cover for homeowners and renters wouldn’t help to build resilience… and building resilience fundamentally means filling the protection gap. I am absolutely motivated to ensure that people who are impacted by natural catastrophes have financial protection and can recover from losses quickly. Developing resources and financial products that tap into human optimism can fill this gap And in my mind, if I had to choose only one thing to help close the protection gap, it would be to align the products (and the resources) that are available with human psychology. Human beings are not wired to process and consider low-probability, high-consequence catastrophe events. But if we can develop resources and financial products that tap into human optimism then potentially we can fill this protection gap. Providing a bit of money to jumpstart the post-earthquake recovery process will help to transform consumer thinking around earthquakes from, ‘this is a really bad peril and I don’t want to think about it’ into, ‘it won’t be so bad because I will have a little bit of resource to bounce back’. Evan Glassman President and CEO, New Paradigm Underwriters  There’s a big disconnect between the insured loss and economic loss when it comes to natural catastrophes such as U.S. windstorm and earthquake. From our perspective, parametric insurance becoming more mainstream and a common and widely-adapted vehicle to work alongside traditional insurance would help to close the protection gap. The insurance industry overall does a good job of providing an affordable large limit layer of indemnity protection. But the industry is only able to do that, and not go out of business after every event, as a result of attaching after a significant buffer layer of the most likely losses. Parametric insurance is designed to work in conjunction with traditional insurance to cover that gap. The tranche of deductibles in tier one wind-zones from the Gulf Coast to the Northeast has been estimated at $400 billion by RMS… and that’s just the deductible tranche. Parametric insurance is designed to work with traditional insurance to cover the gap The parametric insurance space is growing but it hasn’t reached a critical mass yet where it’s a mainstream, widely-accepted practice, much like when people buy a property policy, they buy a liability policy and they buy a parametric policy. We’re working towards that and once the market gets there the protection gap will become a lot smaller. It’s good for society and it’s a significant opportunity for the industry as it’s a very big, and currently very underserved market. This model does have the potential to be used in underdeveloped insurance markets. However, I am aware there are certain areas where there are not yet established models that can provide the analytics for reinsurers and capital markets to be able to quantify and charge the appropriate price for the exposure.

SHAHEEN RAZZAQ
link
July 25, 2016
Beware the Private Catastrophe

Having a poor handle on the exposure on their books can result in firms facing disproportionate losses relative to their peers following a catastrophic event, but is easily avoidable, says Shaheen Razzaq, senior director – product management, at RMS. The explosions at Tianjin port, the floods in Thailand and most recently the Fort McMurray wildfires in Canada. What these major events have in common is the disproportionate impact of losses incurred by certain firms’ portfolios. Take the Thai floods in 2011, an event which, at the time, was largely unmodeled. The floods that inundated several major industrial estates around Bangkok caused an accumulation of losses for some reinsurers, resulting in negative rating action, loss in share price and withdrawals from the market. Last year’s Tianjin Port explosions in China also resulted in substantial insurance losses, which had an outsized impact on some firms, with significant concentrations of risk at the port or within impacted supply chains. The insured property loss from Asia’s most expensive human-caused catastrophe and the marine industry’s biggest loss since Superstorm Sandy is thought to be as high as US$3.5 billion, with significant “cost creep” as a result of losses from business interruption and contingent business interruption, clean-up and contamination expenses. “While events such as the Tianjin port explosions, Thai floods and more recent Fort McMurray wildfires may have occurred in so-called industry ‘cold spots,’ the impact of such events can be evaluated using deterministic scenarios to stress test a firm’s book of business.” Some of the highest costs from Tianjin were suffered by European firms, with some firms experiencing losses reaching US$275 million. The event highlighted the significant accumulation risk to non-modeled, man-made events in large transportation hubs such as ports, where much of the insurable content (cargo) is mobile and changeable and requires a deeper understanding of the exposures. Speaking about the firm’s experience in an interview with Bloomberg in early 2016, Zurich Insurance Group chairman and acting CEO Tom de Swann noted how due to the accumulation of risk that had not been sufficiently detected, the firm was looking at ways to strengthen its exposure management to avoid such losses in the future. There is a growing understanding that firms can avoid suffering disproportionate impacts from catastrophic events by taking a more analytical approach to mapping the aggregation risk within their portfolios. According to Validus chairman and CEO Ed Noonan, in statements following Tianjin last year, it is now “unacceptable” for the marine insurance industry not to seek to improve its modeling of risk in complex, ever-changing port environments. Women carrying sandbags to protect ancient ruins in Ayuttaya, Thailand during the seasonal monsoon flooding. While events such as the Tianjin port explosions, Thai floods and more recent Fort McMurray wildfires may have occurred in so-called industry “cold spots,” the impact of such events can be evaluated using deterministic scenarios to stress test a firm’s book of business. This can either provide a view of risk where there is a gap in probabilistic model coverage or supplement the view of risk from probabilistic models. Although much has been written about Nassim Taleb’s highly improbable “black swan” events, in a global and interconnected world firms’ increasingly must contend with the reality of “grey swan” and “white swan” events. According to risk consultant Geary Sikich in his article, “Are We Seeing the Emergence of More White Swan Events?” the definition of a grey swan is “a highly probable event with three principal characteristics: It is predictable; it carries an impact that can easily cascade…and, after the fact, we shift the focus to errors in judgment or some other human form of causation.” A white swan is a “highly certain event” with “an impact that can easily be estimated” where, once again, after the fact there is a shift to focus on “errors in judgment.” “Addressing unpredictability requires that we change how Enterprise Risk Management programs operate,” states Sikich. “Forecasts are often based on a “static” moment; frozen in time, so to speak…. Assumptions, on the other hand, depend on situational analysis and the ongoing tweaking via assessment of new information. An assumption can be changed and adjusted as new information becomes available.” “Best-in-class exposure management analytics is all about challenging assumptions and using disaster scenarios to test how your portfolio would respond if a major event were to occur in a non-modeled peril region.” It is clear Sikich’s observations on unpredictability are becoming the new normal in the industry. Firms are investing to fully entrench strong exposure management practices across their entire enterprise to protect against private catastrophes. They are also reaping other benefits from this type of investment: Sophisticated exposure management tools are not just designed to help firms better manage their risks and exposures, but also to identify new areas of opportunity. By gaining a deeper understanding of their global portfolio across all regions and perils, firms are able to make more informed strategic decisions when looking to grow their business. In specific regions for certain perils, firms’ can use exposure-based analytics to contextualize their modeled loss results. This allows them to “what if” on the range of possible deterministic losses so they can stress test their portfolio against historical benchmarks, look for sensitivities and properly set expectations. Exposure Management Analytics Best-in-class exposure management analytics is all about challenging assumptions and using disaster scenarios to test how your portfolio would respond if a major event were to occur in a non-modeled peril region. Such analytics can identify the pinch points – potential accumulations both within and across classes of business – that may exist while also offering valuable information on where to grow your business. Whether it is through M&A or organic growth, having a better grasp of exposure across your portfolio enables strategic decision-making and can add value to a book of business. The ability to analyze exposure across the entire organization and understand how it is likely to impact accumulations and loss potential is a powerful tool for today’s C-suite. Exposure management tools enable firms to understand the risk in their business today but also how changes can impact their portfolio – whether acquiring a book, moving into new territories or divesting a nonperforming book of business. 

EDITOR
link
July 25, 2016
The Next Step in Convergence

EXPOSURE investigates how traditional reinsurers, recognizing that third-party capital provides an opportunity rather than a threat, are opting to build or buy their own insurance-linked securities (ILS) fund management capabilities. The property catastrophe reinsurance industry has undergone a rapid transformation over the past decade as capital from institutional investors has flooded into the sector. Attracted by solid returns and an asset class that is uncorrelated to their other investments, investors steadily increased their allocations to ILS. At the same time as the resulting demand for product has intensified, collateralized reinsurance has overtaken catastrophe bonds as the dominant source of ILS capacity. As this institutional capital flooded into the peak zones of Florida wind, California earthquake and Japanese wind and earthquake, traditional reinsurers initially felt displaced. Excess capital, several years of benign catastrophe losses and differing risk and return appetites among the so-called “alternative” capital has heightened competition and eroded rates-on-line. 2015 saw a 3.5 percent reduction in traditional capital dedicated to reinsurance, down US$13 billion to US$357 billion according to Willis Re, reflecting the challenging operating environment and record volume of M&A activity among other drivers. The reduction was offset by the continued growth in non-traditional capital, which hit new heights of US$70 billion. Opportunity or Threat? Capital Growth for Dedicated ILS Funds and Reinsurer Third-Party Capital Managers More progressive reinsurance companies recognize this non-traditional capital is here to stay and the opportunities it presents if properly harnessed. While dedicated ILS funds still dominate the market in terms of assets under management, in recent years more reinsurers have sought to leverage these opportunities, setting up their own dedicated ILS funds, sidecars or special purpose syndicates to offer cedants a broader array of risk transfer tools while tapping third-party capital. Aspen, Everest Re, Hannover Re and Munich Re were among those who significantly increased sidecar capital earlier in 2016; there was also marked growth in managed fund capacity by Hiscox (Kiskadee Re), Validus Re (AlphaCat) and Lancashire (Kinesis) among others. Some have sought to access third-party capital by investing in existing players, with Leadenhall’s increased stake in Amlin, Markel’s acquisition of CATCo and Endurance’s acquisition of Blue Capital (as part of its acquisition of Montpelier Re), as recent examples. Managed fund capacity arguably combines the best underwriting with the most efficient forms of capital in the markets where it is deployed. The collateralized reinsurance platforms have access to the track record, underwriting expertise and catastrophe modeling and analytics know-how of the parent company, while the parent company gains access to considerable capital not held within its own balance sheet. Reinsurers are also able to target different business through their third-party management capabilities. Generally, pure ILS funds prefer “cleaner”, modelable business, whereas a traditional reinsurance company has access to the whole market. However, a reinsurer-owned fund is able to leverage the parent company’s existing infrastructure, access to business and its suite of risk management and pricing tools in order to offer something that is different from some of the independent ILS funds. Third-Party Reinsurance Capital Volume ($B) This is attractive to investors, particularly those looking to diversify away from property catastrophe peak perils into other classes of business. One trend for the collateralized reinsurance market is its growth outwards, both by territory and line of business. The ability to apply catastrophe models and exposure management tools in this bid for diversification is becoming a key differentiator for ILS funds. “THE ABILITY TO APPLY CATASTROPHE MODELS AND EXPOSURE MANAGEMENT TOOLS IN THIS BID FOR DIVERSIFICATION IS BECOMING A KEY DIFFERENTIATOR FOR ILS FUNDS.” Lancashire’s Kinesis Capital, for instance, has been set up as a multi-class, fully collateralized reinsurance provider covering specialty classes such as marine among its product offerings, albeit backed by a strong analytical approach. And the trend looks set to continue. In April 2016, ILS publication Artemis noted that the launch of the RMS® Marine Cargo and Specie catastrophe risk model would provide an enhanced approach to marine risk quantification, helping ILS investors and capital to increase participation in the marine insurance and reinsurance market. There are signs that some of the independent funds are recognizing the great benefit of having in-house catastrophe modeling and analytics capabilities, opting to license reinsurance catastrophe models or hire reinsurance talent from markets such as Lloyd’s and Bermuda to bolster their offerings. The boundary between the traditional reinsurance market and ILS arena will continue to blur in the coming years as market players seek to combine the best underwriting – and modeling and analytics expertise – with the most efficient form of capital.

Loading Icon
close button
Overlay Image
Video Title

Thank You

You’ll be contacted by an Moody's RMS specialist shortly.