1. Managing Catastrophe Exposures in Mexico: Country Experience How Can Insurance Regulators and Government Policymakers manage catastrophe risk? Manuel Aguilera-Verduzco President of the Insurance and Surety National Commission (CNSF)

2. Catastrophic Risks Insurance Regulation Final Remarks Seismic Risk Contents

3. Catastrophic Risks

4. Mexico’s geographic situation makes it highly vulnerable to natural phenomena. Among the most important risks are: Seismic Volcanic Eruption Hurricane and Hail - Flooding Catastrophic Risks

5. Mexico is highly exposed to earthquakes’ occurrences due to the seismic fault located in the Southeast cost of the country. Seismic risk in Mexico Seismic activity in Mexico is one of the most important around the world. Large earthquakes may cause significant human and economic losses and, potentially, put insurance companies in an insolvency position, especially if not proper regulation is in place. Therefore, the Insurance and Surety National Commission (CNSF) recognised the need of a careful technical analysis of earthquakes’ effects in order to estimate the losses that may be caused by this kind of events.

6. Seismic risk in Mexico The American Continent is divided into six earth fragments: 2 3 4 5 1 6 1. North American Plate 2. Pacific Plate 3. Cocos Plate 4. Nazca Plate 5. Caribbean Plate 6. South American Plate

7. Seismic risk in Mexico Mexico is located in a sub-duction region where several tectonic plates collide. North American Plate Pacific Plate Cocos Plate

8. Earthquakes in Mexico (1908-2003) Magnitude > 6.5° YearMagnitude*YearMagnitude* 19087.719858.1 19097.619867 19117.919896.9 19287.719936.6 1928819946.6 19417.919957.4 19577.719958 19627.219977.3 19657.819997 19687.419997.4 19787.820007 19797.620037.6 * Richter Scale

9. Seismic risk in Mexico The effects of the 1985 earthquake motivated the development of engineering studies and the revision to several by-laws: New technological developments were used to evaluate and measure the phenomenon. A new Building Code was implemented. The EI-UNAM* developed a software in order to asses the seismic risk of Mexican insurance companies’ building portfolios. Adjustments to the insurance regulation were implemented using new technical basis. * EI – UNAM: Engineering Institute of the Universidad Nacional Autónoma de México (UNAM)

10. Insurance Regulation Seismic Risk

11. Insurance Regulation The EI-CNSF System provides 2 elements:  Risk Premium  Probable Maximum Losses It also offers the possibility to compute technical items like the: unearned premium reserve, catastrophic reserve, and the solvency margin.

12. Insurance Regulation Unearned Premium Reserve  It should be constituted with 100% of the risk premium (calculated by the EI-CNSF system). Costs and Profit Risk Premium Unearned Premium Reserve  Is the amount of the unearned premium risk at the time of the valuation.

13. Insurance Regulation Unearned Premium Reserve  It’s calculated by the system requiring a minimum of (mandatory) information in order to measure a building’s probability of damage in case of earthquake. Risk Premium (RP) Optional information + Conservative quota Precisely quota (reduction in the RP) Optional Information Example: Postal code, latitude, use (commercial, residential, industrial), land irregularities, walls’ type, open spaces, building date, etc. Mandatory information Mandatory Information Example: Policy number, insurance term, insured value, % of retention, seismic zone, building type, etc.

14. Insurance Regulation Unearned Premium Reserve  As the premium is earned by the company, the reserve is released in that proportion and is used to increase the catastrophic reserve (in a monthly basis). Catastrophic Reserve Unearned Premium Reserve

15. Insurance Regulation  It was implemented after the experience of the 1985’s earthquake. Catastrophic Reserve  It’s accumulation is confined by a technical limit determined by the Probable Maximum Loss (PML), calculated by the EI-CNSF system.  Is considered as a “long term unearned premium reserve”.

16. Insurance Regulation Catastrophic Reserve (CR) Probable Maximum Loss Scenario 1 Scenario n 2. Expected loss % for each structure 3. PML for each seismic scenario 4. Average of PML = Technical limit % % % % % % Is defined as the total amount of expected portfolio losses during a single critical event and is calculated by the EI- CNSF System. 1. Different seismic scenarios Scenario 2, Scenario 3,..., PML A

17. Insurance Regulation Solvency Margin SR = R1 + R2 The Earthquake SR is defined as: T echnical requirement relative to the earthquake risks retained by the insurer Requirement resulting of deficiencies in the proportional risk cession +  Solvency Requirement (SR)

18. Insurance Regulation Solvency Margin  The Technical Requirement (R1) is defined as the Probable Maximum Loss (calculated by the EI-CNSF System) of a company’s portfolio (PML C ). R1 = PML C Retained cumulus portfolio

19. Insurance Regulation Solvency Margin  The Requirement for the reinsurance’s proportional cession deficiencies (R2) is defined as the percentage of the retained premiums (P R ) that were ceded to non-registered reinsurers* (P CNR ) applied to the PML C of the company’s portfolio. R2 = PML C * (P CNR /P R ) (Non-registered reinsurers index – 1) * This register is granted by the Ministry of Finance to foreign reinsurers with a rating higher than: BBB- (Standard and Poor’s and Fitch); B+ or FRP= 5 (A.M. Best); or Baa3 (Moody’s).

20. Final Remarks

21. The Mexican experience in natural disasters had stimulated the process of regulation improvement, aimed to enhance the financial stance of insurance companies. Final Remarks The Seismic System is an example of the insurance regulators’ effort for managing catastrophic risks taking into account the long term financial viability. Hurricanes’ frequency and severe effects make necessary the development of new technical basis for their regulation. Nowadays, the EI-UNAM-CNSF is working out with a hurricanes’ research, in order to estimate their frequency and severity. Our goal is to have a Hurricane System similar to the seismic one, taking into account Mexico’s specific characteristics.

22. Managing Catastrophe Exposures in Mexico: Country Experience How Can Insurance Regulators and Government Policymakers manage catastrophe risk? www.cnsf.gob.mx maguilera@cnsf.gob.mx