Reinsurance: Managing Catastrophic Risk in a Dangerous World

TABLE OF CONTENTS

INTRODUCTION	1
SECTION 1: THE IMPACT OF NATURAL AND MAN-MADE DISASTERS ON THE WORLD SCENE	2
A WORLDWIDE PROBLEM: UNDERSTANDING THE DISASTER	2
REVIEW	4
THE COST OF NATURAL DISASTERS ON THE INSURANCE INDUSTRY: A CHALLENGING PROBLEM	5
Table 1.1 – Top Ten Global Insured Loss Events in 2022	6
CALIFORNIA: THE STATE ON FIRE	7
THE FREQUENCY OF WILDFIRES IN CALIFORNIA	8
PROPOSITION 103 AND THE LIMITATIONS OF UNDERWRITING REGULATIONS	9
THE CHALLENGE OF CONSTRUCTION COSTS, SUPPLY ISSUES & INFLATION	9
THE RESULTS: WHAT ARE INSURANCE COMPANIES DOING IN CALIFORNIA?	10
REVIEW	10
LEARNING FROM THE PAST: THE INSURANCE INDUSTRY AND FLOOD COVERAGE	11
REVIEW	12
A VICIOUS CYCLE OR A NATURAL ONE?	12
Graph 1.1 – Number of recorded natural disaster evens from 1900-2022	13
Christchurch Earthquake, New Zealand, February 2011	14
Drought, United States, Summer 2012	14
The Great Flood of 2011, Thailand, November 2011	15
Hurricane Sandy, United States, October 2012	15
Hurricane Irma, U.S. Virgin Islands & the United States, 2017	15
Hurricane Maria, Dominica & Puerto Rico, September 2017	16
Hurricane Harvey, United States, August 2017	16
Hurricane Katrina, United States, August 2005	16
Sichuan Earthquake, China, May 2008	17
Tohoku Earthquake & Tsunami, Japan, March 2011	17
REVIEW	17
CONCLUSION: LOOKING TOWARDS THE FUTURE	18
Table 1.2 – Losses Comparison	18
KEY POINTS	19
SECTION 2: THE HISTORY OF REINSURANCE	20
THE HISTORY OF THE REINSURANCE INDUSTRY	21
REINSURANCE IN THE 1300S-1600S: EARLY MENTIONS OF REINSURANCE	21
REVIEW	22
REINSURANCE IN THE 1900s: THE EMERGENCE OF REINSURANCE COMPANIES	22
The Great Fire of Hamburg	24
Carl Von Thieme	25
REVIEW	28
REINSURANCE IN THE 20TH CENTURY: ADAPTING TO A CHANGING WORLD	28
Risk Management	30
REVIEW	32
REINSURANCE IN THE 21ST CENTURY: A FIGHT AGAINST OVERWHELMING ODDS	32
Figure 2.1 – Loss Distribution By Insurance Type for September 11, 2001	33
TRIA	34
Risk-based pricing	36
Subprime borrowers	37
Credit default swaps & derivatives	38
KEY POINTS	39
SECTION 3: REINSURANCE– MANAGING CATASTROPHIC RISK IN A DANGEROUS WORLD	40
TYPES OF CATASTROPHIC EVENTS: GEOPHYSICAL, METEOROLOGICAL, HYDROLOGICAL AND CLIMATOLOGICAL	41
GEOPHYSICAL EVENTS	41
Table 3.1 – Notable Geophysical Events within the Last Two Decades	42
METEOROLOGICAL EVENTS	43
Saffir-Simpson Hurricane Wind Scale	43
Hurricane Category 1 – 5	44
Table 3.2 – Notable Meteorological Events within the Last Two Decades	45
HYDROLOGICAL EVENTS	46
Table 3.3 – Notable Hydrological Events within the Last Two Decades	46
CLIMATOLOGICAL EVENTS	47
Figure 3.1 – The Fire Triangle	48
Table 3.4 – Notable Climatological Events within the Last Two Decades	49
REVIEW	50
REINSURANCE– DEALING WITH THE CONCEPT OF RISK	50
THE PERCEPTION OF RISK HAS EVOLVED OVER TIME: INFORMATION AT OUR FINGERTIPS	50
MORE MONEY, MORE PROBLEMS	51
THE DECLINE OF A RELIGIOUS PERSPECTIVE OF RISK	52
AN EXTERNALIZATION OF GUILT AND RESPONSIBILITY	53
THE PERCEPTION OF RISK IN THE NEW MILLENNIUM	53
Table 3.5 – Top Five Global Risks over the Last Five Years	54
INSURANCE CHANGES THE PERCEPTION OF RISK	56
REVIEW	58
REINSURANCE– EXPERTS AT MANAGING RISK	58
TAKING CONTROL OF RISK: A FRAMEWORK OF STRATEGY AND FUNCTION	59
ASSESSING AND PRICING INSURANCE RISK WITH PROPER UNDERWRITING	60
Randomness, Assessability, Mutuality & Economic Viability	61
MANAGING ASSETS: SETTING AND INVESTING EXPECTATIONS	61
MANAGING CAPITAL: THE BUFFER AGAINST UNEXPECTED LOSSES	62
REVIEW	63
INSURANCE VS REINSURANCE: AN ANALYSIS OF TWO DISTINCT INDUSTRIES	64
WHAT ARE THE SIMILARITIES OF REINSURANCE AND INSURANCE?	65
WHAT ARE THE BENEFITS AND ADVANTAGES OF REINSURANCE?	66
CAPACITY	66
STABILIZATION	67
FINANCIAL MANAGEMENT	67
CATASTROPHIC PROTECTION	67
ADVICE	68
REVIEW	68
BASIC TYPES OF REINSURANCE	68
TREATY REINSURANCE: COVERING BROAD GROUPS OF POLICIES	69
FACULTATIVE REINSURANCE: ASSESSING RISK ON A CASE-BY-CASE BASIS	70
PROPORTIONAL VS NON-PROPORTIONAL: WHO GETS THE SHARE?	71
Table 3.6 – Proportional Reinsurance	71
Table 3.7 – Non-Proportional Reinsurance	72
Loss Cap, Annual Aggregate Limit (AAL), Event Limit	73
A PRACTICAL EXAMPLE OF A REINSURANCE CONTRACT	74
Figure 3.2 – Practical example of a Reinsurance Contract	74
Sample Policy: Article I / Automatic Coverage	75
Sample Policy: Article II / Facultative Reinsurance	76
Sample Policy: Article III / Facultative-Obligatory Reinsurance	77
Sample Policy: Facultative-Obligatory Binding Limits	78
Sample Policy: Article IV / Guaranteed Capacity Reinsurance	79
Sample Policy: Limits of Retention	81
Sample Policy: Policy Plans Reinsured	85
REVIEW	87
APPLYING LINES AND LAYERS TO REINSURANCE TREATIES: A LOOK AT THE BALANCE SHEETS	88
RETROCESSION: REINSURANCE FOR REINSURERS	89
Spiraling / Excess of Loss (XOL)	90
Probable maximum loss	91
NEW OR ALTERNATIVE FORMS OF REINSURANCE	92
INSURANCE-LINKED SECURITIES (ILS)	92
Table 3.8 – Alternative Reinsurance – Catastrophe Bond	93
Table 3.9 – Alternative Reinsurance – Industry Loss Warranty (ILW)	93
Table 3.10 – Alternative Reinsurance – Collateralized Reinsurance	94
Table 3.8 – Alternative Reinsurance – Sidecar	94
A CLOSER LOOK AT THE CATASTROPHE BOND	95
Indemnity Triggers	96
Parametric Triggers	97
Industry-loss Triggers	98
Modeled-loss Triggers	99
A CLOSER LOOK AT THE INDUSTRY LOSS WARRANTY (ILW)	100
KEY POINTS	102
SECTION 4: THEORY VERSUS REALITY– COPING WITH THE PROBLEMS OF THE WORLD	103
THE REAL-WORLD CHALLENGES	104
HOW DOES INFLATION AFFECT REINSURANCE?	104
Higher Claims Payments	104
Lower Investment Value	104
More Risk Taking	105
HOW DO CATASTROPHE AND SECONDARY PERILS AFFECT REINSURANCE?	105
HOW HAS INVESTOR CONCERN AFFECTED REINSURANCE?	106
WHAT ARE REINSURANCE COMPANIES DOING TO MITIGATE THESE PROBLEMS?	107
REVIEW	108
EXPERT ADVICE— NOT SOLVING PROBLEMS, BUT CREATING SOLUTIONS	109
THE REGULATORY SIDE	109
THE MARKET SIDE	111
THE PROFESSIONAL SIDE	111
REVIEW	113
WHAT IS THE FUTURE OF REINSURANCE?	114
HARNESSING DATA AND INVESTING IN NEW TECHNOLOGY AND ANALYTICS CAPABILITIES	114
DIFFERENTIATION AND DESIGNING NEW PRODUCTS AND SERVICES	115
COLLABORATION	115
CONCLUSION: LOOKING TOWARDS THE FUTURE	116
KEY POINTS	117
SECTION 5: COURSE REVIEW	118
SECTION 1: THE IMPACT OF NATURAL AND MAN-MADE DISASTERS ON THE WORLD SCENE	118
SECTION 2: THE HISTORY OF REINSURANCE	121
SECTION 3: REINSURANCE—MITIGATING CATASTROPHIC RISK IN A DANGEROUS WORLD	124
SECTION 4: THEORY VERSUS REALITY— COPING WITH THE PROBLEMS OF THE WORLD	131
REFERENCES	132

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