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Bringing Science to the Art of Underwriting TM 'How installing and running a high quality hazard instrumentation network can facilitate the creation of.

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Presentation on theme: "Bringing Science to the Art of Underwriting TM 'How installing and running a high quality hazard instrumentation network can facilitate the creation of."— Presentation transcript:

1 Bringing Science to the Art of Underwriting TM 'How installing and running a high quality hazard instrumentation network can facilitate the creation of parametric triggers' Robert Muir-Wood OECD 2 nd International Cat Risks Conference Bangkok, Sept 25 th 2009

2 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM Agenda 1 st and 2 nd generation parametric risk transfer structures Instrumentation requirements Role of governments/multilateral agencies to enable parametric risk transfer 2

3 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 3 Investor/Issuer Mismatch - Developed World Issuers Investors Prefer indemnity Dislike basis risk Settling for industry loss or modeled loss Prefer parametric Dislike indemnity Bias for simplicity When they were designing the Cat bond market, they forgot to invite the investors

4 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 4 Investor/Issuer Mismatch - Developing World Issuers Investors No insurance institutions to process claims No reliable historic claims Proportional recovery better than nothing Only parametric is tenable For the developing world – it has to be parametric

5 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM First & Second Generation Parametric 1 st generation parametric is based on the parameters of the event –ie. earthquake magnitude and location (in a geographic box) –Hurricane intensity and track (and distance from the site) 2 nd generation parametric is based on measurements of the hazard at multiple locations –Eg. peak ground acceleration measurements or peak gust windspeed recordings –Weighted by the exposure values and vulnerability in the vicinity of each recorder, a formula is developed and tuned to create an index that closely matches loss Parametric structures require pre-existing Cat model to design correlation with expected loss and risk analysis for the Bond Higher basis risk (mismatch with actual losses) likely for 1 st generation than second generation structures 5

6 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM Caribbean Catastrophe Risk Insurance Facility – 1 st Generation parametric trigger Launched Feb 2007 to provide participating governments with immediate liquidity if hit by a hurricane or earthquake. – For hurricane - trigger based on calculated windspeeds at key exposure concentrations Derived using predefined Rmax of a hurricane However real radius can vary by factor of 10 –For earthquake based on magnitude in a box not ground motion on an island For a small island – there is the potential for no payout when significant loss as well as payout when there is no loss 2 nd generation parametric not used in the Caribbean (in 2007) because of lack of suitable pre-existing windspeed and ground motion instrumentation networks. 6

7 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM Caribbean Insurance Pool Not Affected by Hurricane Dean INSURANCE JOURNAL By David McFadden August 24, 2007 Hurricane Dean will not trigger an insurance pool set up this year by Caribbean countries and the World Bank that provides emergency cash to islands in case of natural disaster, officials said this week. The hurricane, which killed at least 20 people across the region and did extensive damage to bananas and other crops, failed to surpass wind speeds and other thresholds to prompt payments from the disaster pool established in February, according to fund supervisor Simon Young. Jamaica, which sustained the brunt of Dean's destructive path in the Caribbean, came close to being hit hard enough to receive payouts from the Caribbean Catastrophe Risk Insurance Facility. "Had the storm been 30 miles to the north that would have triggered immediate payment in Jamaica,'' Young said from the Washington office of Caribbean Risk Managers Ltd., which oversees the insurance program.

8 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM Requirements for hazard instrumentation networks System must have multiple stations –To ensure regional coverage (average station spacing 20-30km?) –To provide redundancy if a station fails Instruments must be robust and have their own power supplies –Demonstrably able to withstand impacts and/or loss of power from a catastrophic event Maintenance –Must be maintained by an agency that can demonstrate consistent standards of battery replacement and regular testing Independence/Integrity –Must be run by an agency seen to be completely independent of potential interference from parties to a financial transaction. –(Can be a problem for some government organisations.) 8

9 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 9 2 nd generation Parametric Windstorm Index for Europe (based on c 300 windspeed measurements) Lower Basis Risk: Industry loss estimates can be customised by Line of Business and Province/City Increased Granularity: RMS Industry Exposure Database (IED) is at postal code resolution, enhancing the accuracy of industry loss estimates. Better Execution: Increased transparency, simplicity and liquidity for investors translates into better execution.

10 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 10 Eurowind Index Look-up Table The relationship between insured industry losses and peak-gust wind speeds are probabilistically estimated by application of the Europe Windstorm Model to the Industry Exposure Database The Index Look-up Table relates an estimated industry loss per 2 figure postcode to a given wind speed in that postcode for each line of business; in effect representing a set of weighted average vulnerability curves.

11 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 11 Eurowind Index - Historic Performance DateWindstorm NameRegion Impacted Paradex Europe Windstorm 8.0 Index Value Annual Occurrence Exceedance Probability of Index Value 25 th Jan 1990Daria Southern England, Netherlands, Belgium and Germany 12,208bn 1.82% 15 th Oct J Southeast England and southeast Norway 5,180bn 6.37% 25 th Dec 1999Lothar France, Germany, Switzerland 6,732bn 4.52% 25 th Feb 1990Vivian Northern Scotland, Scandinavia, Belgium 5,164bn 6.40% 18 th Jan 2007KyrillNorthern Europe3,298bn 10.86% Daria was the most severe of a series of events that moved into Europe in early The storm caused a trail of destruction across southern England (where the highest peak gust wind speeds approached 44 m/s, or 100 mph), the Netherlands, Belgium, and Germany and caused significant insured losses in Denmark, France and Luxembourg The index value of this event equates to an annual attachment probability around a 1 in 50 year event There have been no examples in recent years of a 1 in 100 year or 1 in 250 year event in the European Region

12 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM But existing stations fail during hurricanes 12 Existing stations are often deactivated during hurricanes There is survival bias – stations that survive are the ones that experienced weaker winds

13 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 13 Anemometers rated to 220mph Cellular link with 1Gb flash backup Solar powered battery backup Secure data transfer and storage Weatherflow Hurricane Network Ten-meter concrete poles Overall station rated to 140mph

14 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 14 Designing a privately financed windspeed recording network for Florida

15 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM Earthquake recording in Japan

16 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 16 Second Generation Paradex earthquake zip Residential index value f(0.3sec, 1.0sec, 3.0sec ) Comml & Ind index value f(0.3sec, 1.0sec, 3.0sec ) zip pre-compiled index value lookup tables SA 0.3sec, SA 1.0sec, SA 3.0sec zip centroid SA values Advanced National Seismic System &partner networks ShakeMap (interpolate) parametric industry loss index values zone Res C&I (zip < zone < state) Paradex-EQ Event Bulletin Initial set-up / update Industry Loss ELT by zip & LoB ?

17 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 17 New instrumentation Discolored activated indicators provide depth reading Cap Technology in use for hydrological applications (and cellphones) Require routine servicing Low cost (<$500/unit) How did they know I dropped my phone in the bathtub? How can we know that the flood was 12 feet deep?

18 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM 18 Low tech solutions have also been employed for 2 nd generation parametric triggers Flood heights can leave a mark on buildings At pre-surveyed locations Heights measured within a few days after event Audited by a highly reputable survey organisation

19 CONFIDENTIAL © 2006 Risk Management Solutions, Inc. TM What can Governments and MLF Agencies do to foster parametric risk transfer? 2 nd generation parametric triggers provide viable low basis risk alternatives to insurance - in particular for developing countries Requires installation of networks of hazard recorders around concentrations of exposure –Hazard recorders need to be highly robust and able to record without external power Supported by an agency that can ensure the maintenance of the equipment and guarantee the objectivity of the observations All organisations/institutions linked with the risk transfer mechanism need to have demonstrable long term integrity Underpinned by models to structure and define index risk analysis However smart instrumentation can promote risk transfer ! 19


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