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Insurance Industry Catastrophe Management Practices
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The American Academy of Actuaries’ Catastrophe Management Work Group was requested
by the Coordinating with Federal Regulators Subgroup on Financial Issues of the
National Association of Insurance Commissioners to develop a report to discuss how
property and casualty insurers manage catastrophe risks. This monograph is in response
to that request and makes the following observations:
n Catastrophe exposures place special demands on insurer capitalization and require a distinct
risk management approach. The risk management process for an insurer must integrate
all risk management strategies of the insurer, not just a single risk, such as catastrophe risk.
The interaction or covariance (versus independence) of the various risks a company faces is
an important factor in determining the company’s total capital requirements.
n For property and casualty insurers, catastrophes are defined as infrequent events that cause
severe loss, injury, or property damage to a large population of exposures.
nWhereas most property insurance claims are fairly predictable and independent,catastrophe
events are infrequent and claims for a given event are correlated. The insurance process, if left
unmonitored during lengthy catastrophe-free intervals, could produce increasing concentra
tions of catastrophe exposure.
n Catastrophes represent significant financial hazards to an insurer, including the risk of insolvency,
an immediate reduction in earnings and statutory surplus,the possibility of forced asset
liquidation to meet cash needs, and the risk of a ratings downgrade.
n Insurers manage catastrophe risk through a continuous learning process that can be
described in five steps. The steps are identifying catastrophe risk appetite, measuring catastrophe
exposure, pricing for catastrophe exposure, controlling catastrophe exposure, and
evaluating ability to pay catastrophe losses.
s Identifying catastrophe risk appetite - An evaluation of catastrophe risk appetite
gives underwriters a guideline for determining whether catastrophe risk in the insured
portfolio is within acceptable limits.
s Measuring catastrophe exposure - The objective of measuring catastrophe exposure
is to be aware of the company’s current exposure to catastrophes, both in absolute
terms and relative to the company’s risk management goals.
s Pricing for catastrophe exposure - In setting rates for catastrophe insurance cover
age, the general trend is away from using a long historical experience period, toward
the application of catastrophe models to current or anticipated exposure distributions.
The shortcomings of using historical premium and loss experience are clear,
and catastrophe modeling has been widely adopted in making rates for hurricane and
earthquake.
s Controlling catastrophe exposure - For various reasons, insurers may decide they
have a need to control or limit catastrophe risk. Usually this results in reducing expo
sure in segments where capacity is exceeded, and using reinsurance or capital market
instruments to transfer exposure to someone else.
Insurance Industry Catastrophe
Management Practices
Executive Summary
s Evaluating ability to pay catastrophe losses - Catastrophe claim payments are
funded through normal operating cash flow, asset liquidation, debt financing, or
advance funding from reinsurers.
n Actuarial standards exist for appropriate application of catastrophe models. Also,
to help regulators evaluate use of the models in making rates, the Catastrophe Insurance
Working Group of the NAIC published the Catastrophe Computer Modeling Handbook in
January 2001.
n Generally, the liquidity (or illiquidity) of an insurer after a catastrophe does not
cause insolvency. Rather, it is the magnitude of the event relative to company surplus.
Insurers must strike a balance between the benefits of being prepared for low-probability
catastrophes and the cost of pre-event preparations.
n There is no one catastrophe risk management procedural template that applies to all insurers.
However, the conceptual elements are the same for any property and casualty insurer.
n Reinsurance is the traditional method used by insurers to transfer risk, but capital markets
are a growing source of alternate capacity. Capital market products developed to date can be
grouped into three categories: insurance-linked notes and bonds, exchange-traded products,
and other structured products.
n Catastrophe risk management for reinsurers is similar to that of a primary company. For a
reinsurer, the challenges are to obtain adequate catastrophe exposure information from ceding
companies, to accurately measure catastrophe exposure aggregations across multiple ceding
companies, and to price for the exposure.
n Insurer catastrophe risk management practices are relevant to certain questions of public
policy. Examples include the amount of insurer capital, whether insurer capital needs to be
segregated for catastrophe purposes, whether to encourage pre-event funding, the tradeoffs
between availability and affordability, the extent of governmental involvement in the market
place, and potential over-reliance on guaranty funds.
n Policy-makers considering actions designed to affect either catastrophe coverage availability
or the solvency of insurers exposed to catastrophe claims can use the five step catastrophe
risk management approach to anticipate market effects of the proposals they are considering.
Generally, policy actions have more than one consequence, and this framework can help to
anticipate secondary (and sometimes unintended) consequences.
A m e r i c a n A c a d e m y o f A c t u a r i e s - Organizational Body
NONE
Management
English
1-44
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