The legislations or regulations on catastrophe risks and the catastrophe insurances accounting requi

1
The legislations or regulations on catastrophe
risks and the catastrophe insurances accounting
requirements established by insurers or
regulators in major EU countries

• Stefan Richter / Rainer SchönbergerGerman
  Insurance Association

2
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial reporting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
3
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial reporting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
4
Starting position (1)

• Large increase in extreme events
• Intensity of events steadily increasing
• Disproportionate rise in losses through
• Increased settlement of exposed areas
• Progressive concentration of assets
• Expansion of basement space and technical
  equipment below ground level
• Climate change
• Actuarial situation
• Low insurance dispersion due to lack of
  demand(problem of negative selection)
• Decline in insurance services for exposed areas
• Cutbacks and price increases in reinsurance
  capacities
• Increase in insurance premiums

5
Starting position (2)
1.1 Past events
Number of emergency losses in Germany since 1970
30
25
20
15
10
5
0
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
Miscellaneous (e.g. forest fires, avalanches,
frost)
Storm
Flooding
Earthquake
Hail
6
Starting position (3)
1.1 Past events
Economic losses (euro millions)
adjusted for inflation
7
Starting position (4)
1.1 Past events
Insured losses (euro millions)
3.2 bill.
2,500
2,000
1,500
1,000
500
0
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
adjusted for inflation
8
Starting position (5)Worldwide climate changes

• Global effects ( IPCC document )
• Increase of 0.6 to 0.8 degrees Celsius in average
  temperature of earths surface in the 20th
  century
• Model calculations for the 21st century show a
  temperature increase of between 1.4 and 5.8
  degrees Celsius
• Rise in sea level by 0.09 to 0.88 metres
• Retreat of glaciers and thawing of permafrost
  soils
• Increase in floods and droughts
• Higher maximum temperatures more hot days and
  heat waves
• Higher minimum temperatures fewer cold days,
  but increase in cold spells
• IPCC Inter-governmental panel for climate change

9
Starting position (6) Effects of global climate
change - temperature
1.2. Climate changes
- Increase in global average temperature in the
21st century for the northern hemisphere and the
polar regions there between2 C and 6 C. -
Increased ice melting - Rise in sea level
10
Starting position (7) Effects of climate change
worldwide precipitations
1.2. Climate changes

• Increase in precipitations in the Asiatic region
  by up to 1.5 mm per day
• In connection with the increase in temperature,
  the climate cycle is increasingly being fuelled
  with energy which will manifest itself in
  distinctive weather phenomena

11
Starting position (8) Effects of climate change
worldwide sea level
1.2. Climate changes

• Depending on the model calculation, the IPCC,
  based on forecasts for global warming in the 21st
  century, anticipates an increase in sea level of
  between 40 cm and 60 cm.
• The increase forecast means that settlement will
  no longer be possible in some regions.
• Even the most conservative model calculation
  shows that numerous islands in the South Seas
  (e.g. Tuvalu) will be flooded, and consequently
  will no longer be habitable.

12
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial reporting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
13
Examination of the European models
(1)Introduction

• Storm and temperature insurance in the following
  countries will be looked at
• France
• Spain
• Switzerland
• Federal Republic of Germany
• The following will be highlighted
• Structure
• Functionality
• Strengths and weaknesses
• The strengths and weaknesses of the German system
  will be shown using the flood catastrophe of
  August 2002 as an example

14
Examination of the European models (2) France -
Structure
Government(CCR)
Reinsurance
Insurance industry

• Proportional RI- RI with unlimited liability

.............
Statespecifiedstandardpremium
Policyholder
PrivateReinsurer
Mandatory for - assets and vehicles - as soon
as they are insuredagainst other risks
Caisse Centrale de Réassurance
15
Examination of the European models (3)France
Functionality (1)

• By law, the French government and the private
  insurance industry are to insure natural disaster
  and storm risks jointly. However, the private
  insurance industry bears the risk, manages the
  insurance portfolios and settles claims.
• Catastrophe insurance can be provided as a
  general obligation, or as a compulsory addition
  to basic cover. France has opted for the
  compulsory route. Insurance is mandatory for all
  assets and land vehicles which are insured
  against fire, other risks or loss of
  business.
• The state specifies a standard premium, except
  for the "storm" risk, which is a percentage of
  the basic insurance premium (e.g. for fire
  insurance). The same is true for deductibles.

16
Examination of the European models (4)France
Functionality (2)

• The state provides insurers with reinsurance
  capacity in two forms
• proportional reinsurance or
• reinsurance with an unlimited state guarantee.
• The proportional reinsurance rates and direct
  insurer deductibles have had to be raised in the
  past in order to keep the state-owned reinsurer
  Caisse Centrale de Réassurance (CCR) solvent.

17
Examination of the European models (5)France
Strengths and weaknesses

• The CatNat system has proved to be unstable since
  its establishment. The main reasons for this
  instability are
• politically motivated interference with claim
  payments and system design
• the conduct of the state reinsurer CCR, which, in
  an attempt to improve its economic position by
  offering low premiums, merely succeeded in
  accumulating exposed risks, thus destabilising
  the system of comprehensive cross-subsidies and
  the model as a whole.

18
Examination of the European models (6)Spain -
Structure
Premium
Federal CatNat insurerConsorcio
Insurance industry
Refund of expenses
Encashment
Adjustmentof claim
Policyholder
Mandatory insurance - buildings and movables
- - motor vehicles - - accident -
19
Examination of the European models (7)Spain
Functionality (1)

• From the systematic point of view, the Consorcio
  does not constitute a general compulsory
  insurance, but mandatory coverage.
• Despite the formal changes introduced in the
  course of deregulation, the Consorcio remains
  Spains government insurance monopoly for
  natural disasters.
• The Consorcio offers compensation for natural
  disasters, as well as losses with political or
  social causes (terrorism, unrest etc.).

20
Examination of the European models (8)Spain
Functionality (2)

• The Consorcio charges "levies" for numerous
  property insurance contracts in the form of
  "levy rates" (these are in fact premium rates)
• The "levy" (insurance premium) is mandatory for
  buildings, building contents, vehicles and
  persons.
• Standardised premium rates and deductibles
  apply.
• Claims settlement is performed by the Consorcio
  itself. Premiums are collected by private
  insurers in return for reimbursement of costs.

21
Examination of the European models (9)Spain
Strengths and weaknesses (1)

• The restructuring of the Consorcio into an
  independent public company subordinated to the
  Finance/Economics Ministry did not alter the
  monopolistic character of this system.
• This assumption is supported by the fact that, in
  practice, policyholders are refused access to
  private alternatives (double insurance since
  the levy to the Consorcio is not dispensed
  with).

22
Examination of the European models (10)Spain
Strengths and weaknesses (2)

• The system does not contain any incentives for
  prevention. Rather, it encourages policyholders
  to place their trust entirely in compensation in
  the event of a loss.
• Due to a lack of reinsurance and risk-related
  premiums, the system will become unstable as
  extreme events become more frequent
• Losses and insured values will increase
• Losses and increases in levies will spiral
• This cycle can only be broken through the
  introduction of structural changes, e.g. by
  encouraging prevention

23
Examination of the European models
(11)Switzerland - Structure
7 Swiss cantons
19 Swiss cantons
Private Insurance industry pool
Government
A/B/Cassign 85 of claims
Cantonalmonopolyinsurer
Pool allocates to A, B, C
Insurer A
Insurer B
Insurer C
Policy-holder
.............
Policyholder
Standard premium
24
Examination of the European models
(12)Switzerland Functionality (1)

• Switzerland systematically chose general
  compulsory insurance rather than mandatory cover.
• There is no standardised national system in
  Switzerland for natural disaster insurance.
• In some of the Swiss cantons, the public cantonal
  building insurers (KGV) offer natural disaster
  coverage as monopolies, while the private
  insurance industry offers such coverage in
  others.
• Each building owner is under an obligation to
  take out insurance not only against the usual
  risks (fire, storm, hail), but also against
  natural disaster risks (flooding, avalanches,
  snow pressure, landslides, rock slides).

25
Examination of the European models
(13)Switzerland Functionality (2)

• Risks are balanced within the private insurance
  industry through a pool of private insurers.
• Companies assign 85 of their natural disaster
  claim expenses to the pool, which distributes the
  claims burden across all of the pool members in
  proportion to the premium revenue of the relevant
  company. The private insurance sector is thus
  able to meet its obligation of compensation for
  losses.
• On the other hand, the public cantonal building
  insurers rely solely on the extensive financial
  reserves they have accumulated in the past

26
Examination of the European models
(14)Switzerland Strengths and weaknesses

• The private insurance sector is restricted to 7
  of the 26 cantons. These 7 cantons, however, do
  not reflect the risk situation of Switzerlands
  federal territory. The opportunities for the
  private insurance sector to spread risk
  adequately are therefore heavily restricted.
• Switzerlands system does not offer a
  comprehensive solution for loss through
  catastrophe, as the policyholder, by virtue of
  limited liability to 25 million CHF per case of
  loss and 250 million CHF per event (for all
  losses !) must, in the event of doubt, bear the
  costs for a portion of the loss himself. This
  applies to both private and cantonal insurers.

27
Examination of the European models(15) Germany -
Structure
Government
Private Insurance industry
At present, not involved
Demand
Supply
Premium
Claims adjustment
Policyholder
28
Examination of the European models(16)Germany
Functionality (1)

• The insurance market in the Federal Republic of
  Germany has been deregulated since 1994, so that
  insurance for natural risks is offered by the
  private insurance industry rather than by a state
  monopoly.
• The Special Terms and Conditions of the private
  insurance industry only covered the following
  risks
• Flooding (including heavy rains, pressurised
  water and backwater)
• Earthquakes, land subsidence, landslides
• Snow pressure, avalanches
• Volcanic eruptions
• Storm

29
Examination of the European models(17)Germany
Functionality (2)

• Insurance is voluntary.
• The scope covers approx. 90 of inhabited areas
  however, due to the general publics lack of
  awareness of risk demand, it is modest.
• There are no standard premium rates or
  deductibles insurers must calculate them using
  statistical data and management ratios.
• Because each risk has to be assessed on a
  case-by-case basis using statistical data, the
  zoning system ZÜRS has become an important
  element of catastrophe insurance in Germany.

30
Examination of the European models (18)Germany
Functionality - ZÜRS (1)

• ZÜRS (Z)onierungssystem für (Ü)berschwemmung,
  (R)ückstau und (S)tarkregen zoning system for
  floods, backwater and heavy rains
• ZÜRS provides an underwriting tool for the
  insurance industry which helps it to assess flood
  risk and offer a risk-related premium.
• At the heart of the ZÜRS system is a database
  which uses address information (road network,
  house number data etc.) to show the risk of
  flooding for any requested area.
• ZÜRS is used as a technical basis for future
  automated zoning systems (e.g. earthquake zones)

31
Examination of the European models (19)Germany
Functionality - ZÜRS (2)

• The ZÜRS software modules
• Three modules ZÜRS Viewer, Blackbox and ZÜRS
  light database
• Modules are adapted to their intended use, e.g.
• ZÜRS Viewer with graphic output at point-of-sale
• Blackbox for batch processing of small-scale
  volumes of data at branch offices
• ZÜRS light database for implementation of the
  data in the insurance industrys mainframe
  computers. Automated data interrogation possible
  for the official in charge.

32
Examination of the European models (20)Germany
Functionality - ZÜRS (3)
Data basisDigital elevation model
Digital terrain model
Digital terrain model as basis of
work Extraction of elevation models from the
terrain model Creation of an elevation for
Germany
Digital elevation model
33
Examination of the European models (21)Germany
Functionality - ZÜRS (4)
Data basisWaterway network
High degree of accuracy 1st and 2nd
orderwaterways flood-affected small-scale
waterways recorded 50,000 kilometres of waterways
are digitised
34
Examination of the European models(22)Germany
Functionality - ZÜRS (5)
Calculation offlood areas

• Hydrology
• - Specification of flood drainage
• 2. Statistics
• - Specification of basis for water quantity
  assessment
• 3. Hydraulics- Location calculation
  (drainage quantity, valley profile, roughness,
  speed, drop)- Narrow simulation grid

35
Examination of the European models (23)Germany
Functionality - ZÜRS (6)
Calculation offlood areas

• 10-yearly flood
• 50-yearly flood
• 200-yearly flood
• Co-ordination with the water economy
• Printout of results on analogue maps
• Visit to
• 200 water authorities
• Increased quality through
• Consideration of anthropogenic influences
• Incorporation of events that have actually
  occurred
• Consideration of more accurate calculations

36
Examination of the European models (24)Germany
Functionality - ZÜRS (7)
Zone division in ZÜRS 2004

• GK 4, high threat
• Statistically, flood at least once every 10 years
• GK 3, medium threat
• Statistically, flood at least once every 10-50
  years
• GK 2, low threat
• Statistically, flood at leastonce every 50-200
  years
• GK 1, very low threat
• Statistically, flood less frequent than once
  every 200 years

GK1
GK4
GK2
GK3
37
Examination of the European models (25) -
GermanyStrengths and weaknesses using the flood
of August 2002 as an example

• In 2002, the Federal Republic of Germany was
  affected by an extreme flood event
• At the time,
• only 5 of buildings and
• 10 of household goods in Germany were covered by
  catastrophe insurance,
• even though insurance could have been taken out
  for around 90 of the areas concerned.
• The German system suffers from the fact that
  supply and demand have no common ground.
• Despite the substantial economic losses incurred
  by the flood catastrophe, demand remained low(?
  suppression of risk)

38
Examination of the European models (26)
GermanyStrengths and weaknesses using the flood
of August 2002 as an example

• Degree of economic loss
• Heaviest precipitations since weather records
  began in 1896
• Total loss 9.1 billion (not including
  flood-related loss of earnings)
• Commercial areas affected businesses, industry,
  trade, inland waterway transportation,
  agriculture, tourism, infrastructure (roads,
  bridges, sections of railway line, power supply
  etc.)
• Environmental damage as a consequence of heavy
  pollution of waterways

39
Examination of the European models (27)
Germany Strengths and weaknesses using the flood
of August 2002 as an example

• Loss areas involved
• Infrastructure of Länder and municipalities
  3.316 billion
• Private households (residential buildings and
  household goods) 2.547 billion
• Commercial activity 1.438 billion
• Federal infrastructure1 1.353 billion 
• Intervention and catastrophe prevention costs in
  the Länder 0.224 billion
• Agriculture 0.192 billion
•  1 Bahn AG facilities, federal motorways,
  federal highways, federal waterways,
  government-owned property, as well as the costs
  for the deployment of over 73,000 workers drawn
  from the Technisches Hilfswerk relief
  organisation, the armed forces and the Federal
  Border Police

40
Examination of the European models (28)
Germany Strengths and weaknesses using the flood
of August 2002 as an example

• Problems caused by state financing of flood
  damage
• The state paid out substantial subsidies to
  citizens affected by the flood in 2002
• However, continual compensation through state
  subsidies whenever catastrophes occur is causing
  considerable problems
• A large number of claims (municipal and district
  authorities, regional and federal ministries,
  Reconstruction Loan Corporation, Deutsche
  Ausgleichsbank and other institutions)
• Parallelism of administrative procedures
• Rapid, unbureaucratic aid was severely hampered
• Release of funds slow as a result

41
Examination of the European models (29)
GermanyStrengths and weaknesses using the flood
of August 2002 as an example

• Problems caused by state financing for flood
  damage (contd)
• Question Can financing of flood damage through
  taxation be justified?
• Equal status of insured and uninsured change of
  moral risk?
• The insured could have saved their premiums
• Critically important that insurance compensation
  is put before state reimbursement
• Question State help only in the event of major
  damage events?

42
Examination of the European models (30)
GermanyStrengths and weaknesses using the flood
of August 2002 as an example

• Economic need for action - conclusion
• Distribution discussion ex post leads to high
  degree of uncertainty among affected parties(no
  contractual regulation such as contracts of
  insurance)
• A large number of parties involved means a
  less-efficient solution (in addition to the lack
  of a general framework and non-existent
  experience of handling of damages)
• Parallelism of voluntary private provision and
  extensive public aid(leads to displacement of
  private insurance with a higher requirement for
  public resources)
• ? Development of a concept from the economic
  aspect is required

43
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial accounting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
44
Catastrophe Insurance project in GermanyProject
commission

• Preliminary considerations
• on the extent of insurance cover(product design,
  risks, deductibles etc.)
• on risk potential, rates and reinsurance
• Development of actuarial models
• based on obligatory insurance
• or in the form of compulsory insurance
• The following will also be examined
• Original insurer model
• Reinsurer model

45
Catastrophe Insurance project in GermanyProduct
(1)

• Insured risks
• Flood / heavy rains / backwater / pressurised
  water (natural cause)
• Storm tide
• Earthquake(fire due to earthquake is also
  covered)
• Landslide(natural collapse of ground above
  natural hollow spaces)
• Landslip
• Snow pressure / avalanches
• Storm / hail

46
Catastrophe Insurance project in Germany Product
(2)

• Uninsured risks
• Cavity following drought
• Gradual damage, etc.
• Volcanic eruption
• Meteorite impact
• Standard exclusions(political risks, including
  acts of terror, fire etc., nuclear power, mains
  water, frost, lightning, short circuit and excess
  voltage damage)

47
Catastrophe Insurance project in Germany Product
(3)

• Insured objects
• Buildings used for housing purposes (minimum
  50), including neighbouring buildings
• ? Backup definition of the term building
• Buildings with primarily commercial (but also
  agricultural) use up to 5 million sum insured
• Cost item limited to 10 of the indemnification
  limit up to a maximum of 100,000

48
Catastrophe Insurance project in Germany Backup
Definition of the term building

• A building is a spatial enclosure designed for
  the protection of persons, animals or objects
  against the effects of weather. Permanently fixed
  to the ground, it is sufficiently stable to
  permit the accommodation of persons.
• Necessary accessories such as sanitary, heating,
  water and electrical installations, built-in
  kitchen furniture and neighbouring buildings
  (e.g. garages, car ports or garden sheds) are
  included in building insurance cover

49
Catastrophe Insurance project in Germany Product
(5)

• Uninsured objects / damage
• Buildings not ready for use(first-time purchase)
• Buildings earmarked for demolition
• Contents, BU (Berufsunfähigkeit? occupational
  disability)
• Isolated special-purpose buildings (allotment
  sheds, field barns, etc.)

50
Catastrophe Insurance project in Germany Product
(6)

• Insurable value
• Reinstatement value with dynamisation
• Procedures still need to be developed for binding
  arrangements in individual cases and on how to
  handle changes in assets where a total limit
  applies
• Deductibles
• Exposed risks (ZÜRS zones III and IV storm tide,
  earthquake)Deductible of 5 of sum insured,
  min. 5,000, max. 50,000 per event and place
  of insurance.
• Non-exposed risks deductible of 0.5 of sum
  insured, min. 500, max. 5,000 per event and
  place of insurance.

51
Catastrophe Insurance project in Germany Product
(7)

• Event definition
• Risk of flood 168 hours
• All other risks 72 hours
• Subject to approval of reinsurers
• Cost unit rate of product
• Operating, claims processing and commission costs
  should be taken into account
• Savings can be generated by using existing
  structures in acquisition and administration
• Capital costs must be considered separately.

52
Catastrophe Insurance project in Germany Product
(8)

• Premium adjustment clause
• Premium-related consideration of rising claims
  expenditure, climate change and risk of error.
• Designed without a threshold value
• Premium adjustment clause
• Necessary in order to be able to respond to
  unexpected developments, e.g. in individual cases
  of damage.
• Sustainability and control
• Sustainability and control must be ensured by
  local authority areas.
• Time of implementation
• Duration of implementation about 2 years after
  law comes into force.

53
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial accounting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
54
Catastrophe Insurance project in Germany Risk
potential and rates (1)

• Assessment of total insurance portfolio
• All residential buildings
• Commercial buildings up to 5 million
• Commercial buildings include buildings used for
  agricultural purposes
• The current portfolio for fire is being assessed
  (in the case of fire, there is almost 100
  insurance dispersion)
• Sources Industry and risk statistics
• Estimate of model-related sum insured ca. 8.5
  billion
• Based essentially on sliding replacement value
  insurance        

55
Catastrophe Insurance project in Germany Risk
potential and rates (2)

• Deductibles model per case of damage /
  policyholder
• For exposed risks
• 5 of sum insured, minimum 5,000, maximum
  50,000
• Flood zones 3 and 4 in accordance with ZÜRS 2004
• Earthquake earthquake zone 3
• Storm tide storm tide zone
• For all other risks
• 0.5 of sum insured, minimum 500, maximum
  5,000
• Note If property relating to one risk is
  assessed as exposed, then the high deductible is
  only applied to that risk!

56
Catastrophe Insurance project in Germany Risk
potential and rates (3)
Estimate of risk potential Simulation / Flooding
Computer-generated three-dimensional elevation
models, with addition ofconcentration of assets
Extent of flood using inflows, outflows and
contour lines
Extent of flood taking into account embankments,
weir etc.
57
Catastrophe Insurance project in Germany Risk
potential and rates (4)
Estimate of risk potential Simulation /
Earthquake
Analysis of damage events(epicentres, causes and
effects)
Simulation, taking into account tectonic
structures and geophysical research results
Analysis of tectonic measurement data
58
Catastrophe Insurance project in Germany Risk
potential and rates (5)

• Estimate of risk potential
• Applied models
• Internal simulation systems of reinsurers
  Münchner Rück and Swiss Re
• Commercially available systems
• EQECAT
• RMS (no model available in Germany for flooding /
  earthquakes Storm Clear deviations from other
  models, little suitable data)
• The results in the simulation systems were in a
  manageable range? sufficient validity of
  findings

59
Catastrophe Insurance project in Germany Risk
potential and rates (6)

• Estimate of risk potential
• Classification by
• CRESTA zone (earthquakes)
• The CRESTA (Catastrophe Risk Evaluating and
  Standardising Target Accumulations) zone data is
  based on the zoning system established by the
  world's leading reinsurers.
• Based primarily on the observed or expected
  seismic activity within a country, CRESTA zones
  consider the distribution of insured values
  within a country as well as administrative or
  political boundaries for easier assessment of
  risks.
• Postcode areas in Germany
• Classification by postcode area permits a more
  detailed examination per territory of the Federal
  Republic of Germany than would be possible by
  just taking into account the CRESTA zones

60
Catastrophe Insurance project in Germany Risk
potential and rates (7)

• Estimate of risk potential
• Calculation using meteorological, hydrological
  and seismological models
• Calculations of the various reinsurers involved
  and results of various suppliers of software for
  cumulative estimate
• Based on international custom, the figures 200
  and 300 were used as yearly units.
• Between 200 and 300 years there is a clear
  increase in potential
• Varying estimates of discharge effects through
  deductibles with extreme events extend the margin
  of estimates
• A year takes the reciprocal of the probability of
  one year being exceeded, i.e. a level x event
  occurs with probability p within a (calendar)
  year.

61
Catastrophe Insurance project in Germany Risk
potential and rates (8)

• Risk potential Storm excluding deductible
• 200-year 7 9 billion
• 300-year 9 12 billion
• Risk potential Storm with deductible model
• 200-year 3.8 5.5 billion
• 300-year 5.5 8.5 billion
• Notes
• The yearly PML is higher
• Realistic worst-case scenarios not possible
• Increasing probability of occurrence (climate
  change)

62
Catastrophe Insurance project in Germany Risk
potential and rates (9)

• Risk potential Flood excluding deductible
• 200-year 7.5 10 billion
• 300-year 9 12 billion
• Risk potential Flood with deductible model
• 200-year 5.5 8 billion
• 300-year 6.5 9.5 billion
• Notes
• The yearly PML is higher
• Realistic worst-case scenarios not possible
• Increasing probability of occurrence (climate
  change)

63
Catastrophe Insurance project in Germany Risk
potential and rates (10)

• Risk potential Earthquake excluding deductible
• 200-year 6.5 9 billion
• 300-year 9 12 billion
• Risk potential Earthquake with deductible model
• 200-year 5 8 billion
• 300-year 7 10.5 billion
• Note
• Realistic worst-case scenarios not possible

64
Catastrophe Insurance project in Germany Risk
potential and rates (11)

• Risk potential Storm tide
• Revision of existing scenarios ( 10-20 billion)
  carried out by the storm tide working party of
  the GDV. The studies are not yet complete.
• Risk potential Other risks under 1 billion

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Catastrophe Insurance project in Germany Risk
potential and rates (12)

• Notes on risk potential
• Individual risk potential is calculated on an
  event basis
• The yearly PML can be above the PML of the
  individual event
• The loss burden must be added for the PML event
• Because of volatility, several events can
  accumulate per year
• Events can also occur in correlation to one
  another

66
Catastrophe Insurance project in Germany Risk
potential and rates (13)

• Conclusions from risk potential
• In order to ensure adequate cover for the
  scenarios illustrated, an annual capacity of 30
  billion is required for the Federal Republic of
  Germany.
• However, only 6-8 billion in capacities is
  available in the private sector in the Federal
  Republic of Germany.
• In order to cover the shortfall, a government
  guarantee of 22 billion is required
  Capacities of original insurers and reinsurers
  operating in Germany

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Catastrophe Insurance project in Germany Backup
Purchasing reinsurance (1)

• Based on a government guarantee, the following
  aspects should be taken into account when
  purchasing reinsurance by line
• By line purchasing distinguishes between risks
• Targeted purchasing is possible
• Higher capacities are available
• One-off replenishment per capacity is usual and
  available on the market at favourable cost
• Similarly, however, the government guarantee
  would have to be shown per risk.
• However, this conceals the risk that, in cases of
  extreme damage, the financial resources of a risk
  line would be exhausted, while the funds for
  other lines remain untouched.
• A capacity shortfall could be avoided if each
  risk line were afforded a maximum capacity of
  22 billion however, there is no discernible
  political will at present in this respect.

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Catastrophe Insurance project in Germany Backup
Purchasing reinsurance (2)

• Purchasing reinsurance as a package
• Package purchasing is the simpler solution
• Only limited capacities available on the market
• However, because of the difficulties described
  with reinsurance by line, package reassurance
  is preferred

69
Catastrophe Insurance project in Germany Risk
potential and rates (14)

• Annual expected loss
• Calculation of expected loss is based on models
• The various estimates of event loss distribution
  are systematically assumed
• Method-constant procedure The mean value of the
  estimates was systematically taken
• Plausibility checks with various risk insurance
  rates or GDV studies

70
Catastrophe Insurance project in Germany Risk
potential and rates (15)

• Estimate of gross premium incomeTotal budget
  excluding storm tide
• The following expenditure should be taken into
  account
• Risk premium
• Balance of reinsurance
• Equity capital costs
• Administrative costs
• Total gross premium is roughly 3.3 billion over
  about 18.5 million contracts
• This represents a gross contribution rate of
  around 0.40 in relation to the building values
  represented

• Expected profit
• Safety loading
• Severe loss reserve
• ...

71
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial accounting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
72
Catastrophe Insurance project in Germany
Actuarial models (1)

• The following steps were taken
• Investigation and decision about which insurance
  system is to be used
• Compulsory insurance system, or
• Compulsory contributions system
• Investigation and decision about which insurance
  model is preferred within the chosen system
• The original insurer model, or
• The reinsurer model

73
Catastrophe Insurance project in Germany
Actuarial models (2)

• Definition of terms
• Compulsory insurance
• For the regulation existing in accordance with
  the law governing compulsory insurance, a
  corresponding insurance policy must be taken out
  by the owner for an object defined in law.
• Compulsory contributions
• A statutory obligation to take out catastrophe
  insurance only exists if the policyholder takes
  out a policy for specific, statutorily-defined
  basic risks where catastrophe insurance is
  mandatory.

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Catastrophe Insurance project in Germany
Actuarial models (3)

• Compulsory insurance (1)
• Advantages of compulsory insurance
• As a general obligation exists for insurance,
  market density of 100 is guaranteed
• Policyholders cannot escape this obligation by
  the fact that they no longer take out basic
  insurance
• Compulsory insurance can be offered as a separate
  product by a large number of insurers

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Catastrophe Insurance project in Germany
Actuarial models (4)

• Compulsory insurance (2)
• Disadvantages of compulsory insurance
• The system has to be sustained and controlled by
  the government at high administrative cost in
  order that the objects defined by law are
  actually insured
• Designing this as a separate product results in a
  higher cost burden (e.g. IT, administration
  costs, operating costs)
• The higher costs lead, in turn, to a further
  burden on insurers and premium payers alike

76
Catastrophe Insurance project in Germany
Actuarial models (5)

• Compulsory contributions (1)
• Make-up of compulsory contributions
• Mandatory insurance against force majeure risks
  for residential buildings, as well as for
  buildings used for commercial and agricultural
  purposes.
• Premium is made as a surcharge for fire insurance
  (possible as a percentage surcharge or as a
  premium rate the latter solution offers more
  adequate risk management, as the fire insurance
  premium does not represent a basis for
  calculating force majeure risks)

77
Catastrophe Insurance project in Germany
Actuarial models (6)

• Compulsory contributions (2)
• Compulsory contributions offer the following
  advantages
• Portfolio management is simpler and more
  cost-effective as no additional contract has to
  be entered into. This means that both insurers
  and premium payers are spared additional costs.
• Existing catastrophe insurance contracts could be
  transferred (since, in most cases, they are
  maintained as an annex to fire insurance in the
  portfolios)
• The high level of bureaucracy involved in
  sustaining and controlling compulsory insurance
  no longer applies

78
Catastrophe Insurance project in Germany
Actuarial models (7)

• Result of examination of the insurance system
• The political climate supports compulsory
  insurance for the following reasons
• Fear that insurers will change their acceptance
  behaviour on underwriting basic cover
• Non-existence of 100 market cover with
  compulsory contributions
• ? On this basis, it was assumed during the course
  of further considerations of the various
  insurance models that catastrophe insurance
  should be introduced as compulsory insurance

79
Catastrophe Insurance project in Germany
Actuarial models (8)

• Preliminary comments on the examination of the
  insurance model
• The fundamental features of the German insurance
  market are
• strong regionalisation of the market (history of
  the origins of companies), and
• extremely diverse exposure of insurers in respect
  of catastrophe risks
• In order to guarantee a functioning risk spread,
  a specialist catastrophe insurer is required
  which bundles all risks
• Such a specialist catastrophe insurer can be
  either an original insurer or a reinsurer

80

• Catastrophe Insurance project in Germany
• Actuarial models (9)

Policyholder
Original insurer model
Subscription agent only (commission-based
brokerage, portfolio management and claims
processing)
Original insurers operating in Germany
Commitment to contract
Regulated price per zone and risk type
Specialist original insurer (AG)
Equity capital/Shareholder
Aggregate excess of loss capacity (capacity
across all risks of reinsurers resident in
Germany)
Reinsurance
Government guarantee
Insolvency of specialist original insurer in the
event of loss expenditure exceeding a limited
government guarantee
81
Catastrophe Insurance project in Germany
Actuarial models (10)

• Evaluation of original insurer model
• The original insurer model has numerous
  disadvantages
• Portfolio losses with the inclusion of storm
  insurance can create financial problems,
  particularly for smaller insurers
• Damage to market approach distribution of
  products of a third-party company
• Elimination of competition (cartel law!)
• Staff redundancies between original insurer and
  specialist original insurer splitting of
  underwriting and policy formulation functions not
  permissible
• High IT investment
• ? Because of these disadvantages, the initial
  insurer model has been rejected

82
Catastrophe Insurance project in Germany
Actuarial models (11)
Reinsurer model
Policyholder
Risk-ceding original insurers
Full cession to specialist reinsurers / avoidance
of negative selections
Retrocession 100 of primary
Cession in return for reinsurance commission
Regulated price per zone and risk type
Specialist reinsurer (AG)
Equity capital / Shareholder
Aggregate excess of loss capacity across all risks
Reinsurance

• Government
• guarantee

Limit of liability in relation to original
insurer and insured required in the event of an
insufficient government guarantee(Limited
liability may not apply if, including retention
and reinsurance, total liability coverage of
30 billion is available)
83
Catastrophe Insurance project in Germany
Actuarial models (12)

• Evaluation of reinsurer model
• The reinsurer model has the following advantages
• Participation in course of business through
  retrocession to original insurers
• Customer relationship remains with the original
  insurer
• Portfolio management / support by original
  insurer
• Net risk bearer is a catastrophe reinsurer
• Less complicated than original insurer model in
  terms of cartel law
• Avoidance of staff and IT-related redundancies in
  the areas of underwriting, administration and
  claims processing

84
Catastrophe Insurance project in Germany
Actuarial models (13)

• Evaluation of reinsurer model
• Despite the stated advantages, the reinsurer
  model entails a deep fracturing of the German
  insurance market as it requires both
• the creation of a standard product, and
• a regulated flat premium
• However, the advantages outweigh the
  disadvantages when compared with the original
  insurer model

85
Catastrophe Insurance project in Germany
Actuarial models (14)

• Result of comparison of original insurer and
  reinsurer models
• The reinsurer model is preferred subject to
  current solvency requirements for original
  insurers.
• To avoid a second retention of original insurers
  (risk of ruin!), this model requires a total
  capacity of 30 billion p.a.

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Catastrophe Insurance project in Germany Backup
Other models

• Government- and tax-financed models have not been
  considered in Germany, as policy guidelines
  dictate that only actuarial models should be
  tested.
• The background to this decision is the general
  disadvantages of government- and tax-financed
  models
• These models generally lack a facility for
  regional risk spreading
• In the case of a loss, a lack of specific purpose
  for resources can mean that the resources
  necessary for compensation for damages are not
  available
• The stated models involve intervening in the
  existing free market

87
Catastrophe Insurance project in Germany
Actuarial models (15)

• Intermediate result
• In Germany, an annual capacity of 30 billion is
  required for the implementation of mandatory
  catastrophe insurance or compulsory catastrophe
  insurance
• Implementation of a limit of liability (per
  policy / per event) is not feasible for both
  political and legal reasons.
• The structure of the reinsurance must reflect the
  above government guarantee.
• However, in order not to be burdened with
  handling frequent damages or small-scale damage
  events, the government will only provide capacity
  within the context of a reinsurer of the last
  resort

88
Agenda - Catastrophe insurance in major EU
countries
? Starting position
? Examination of the European models
? Catastrophe Insurance project in Germany
? The product
? Risk potential and rates
? Actuarial models
? Rates and reinsurance
? Financial accounting and solvency
? Assessment of the overall situation
? Annex Verification structure for
catastrophe insurance
89
Catastrophe Insurance project in Germany Rates
and reinsurance (1)
Structure of reinsurance
Government guarantee
2nd layer
Reinsurance to German and international reinsurers
1st layer
Capacity of original insurers(with or without
retrocession)
Primary
90
Catastrophe Insurance project in Germany Here
Premium flow, solvency requirements in the
reinsurance model (2)
Compulsorily insuredbuilding owners
Shareholders
Equity yield rate
Gross premiums
Gross premiums
All original insurers
Catastrophe reinsurer
Government guarantee
Refund of costs
Provision for risks
-
Administration costs
Solvency requirement
Solvency requirement
Solvency requirement
3rd layer
Retro premiums, incl. capital costs
Reinsurance premium
Reinsurer
2nd layer
Solvency requirement
1st layer
91
Catastrophe Insurance project in Germany Backup
Rates and reinsurance (2a)

• Notes on the Premium Flow diagram
• The limits of the individual layers would have to
  be negotiated specifically as required.
• Solvency requirements are derived from existing
  regulations or for catastrophe reinsurance
  through analogy conclusions. Only the premiums
  index is represented.
• The equity yield rate for the transferred
  business (original insurers as retrocessionaries)
  is paid in settlement via the retro premium.
• Effects of Solvency II are not taken into account

92
Catastrophe Insurance project in Germany Rates
and reinsurance (3)

• Risk differentiation
• In accordance with the non-binding risk premium
  rates published to date, or more precisely the
  Associations studies, the following regional
  differentiations have been investigated in an
  initial project phase
• Four ZÜRS zones
• Three earthquake zones
• Two storm zones
• Two storm tide zones
• Further differentiations were not the subject of
  the discussion.

93
Catastrophe Insurance project in Germany Rates
and reinsurance (4)

• Spread of ratesin connection with the relevant
  zones is considerable
• The following two approaches are possible
• Percentage distribution Here, costs are charged
  as a percentage of net premiums. This means that
  exposed zones have to bear much higher costs than
  favourable zones.
• Sum insured-dependent distribution Sum
  insured-dependent distribution of costs is also
  conceivable. This would enable the lowest
  possible cost burden - even for exposed risks.
• This point has not yet been finally decided.

94
Catastrophe Insurance project in Germany Rates
and reinsurance (5)
- Note -Example of calculationusing fictitious
parameters

• Abstract example
• Percentage distribution
• Of a non-exposed risk
• Ins. 300,000 0.18o net premium 54
  e.g. 50 surcharge for
  costs 27 Gross premium 83
• Of an exposed risk
• Ins. 300,000 1o net premium 300
  e.g. 50 surcharge for
  costs 150 Gross premium 450

95
Catastrophe Insurance project in Germany Rates
and reinsurance (6)
- Note - Example of calculationusing fictitious
parameters

• Abstract example
• Sum insured-dependent distribution
• Costs are calculated independently of claims
  expenditure
• Of a non-exposed risk
• Ins. 300,000 0.18o net premium 54
  e.g. 0.2o surcharge
  for costs 60 Gross premium 114
• Of an exposed risk
• Ins. 300,000 1o net premium 300
  e.g. 0.2o surcharge