Bringing Science to the Art of Underwriting™

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'How installing and running a high quality hazard instrumentation network can facilitate the creation of parametric triggers'

Robert Muir-Wood

OECD 2nd International Cat Risks Conference

Bangkok, Sept 25th 2009

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Agenda

1st and 2nd generation parametric risk transfer structures

Instrumentation requirements

Role of governments/multilateral agencies to enable parametric risk transfer

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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”

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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

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First & Second Generation Parametric 1st 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)

2nd 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 1st generation than second generation structures

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Caribbean Catastrophe Risk Insurance Facility – 1st 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

2nd generation parametric not used in the Caribbean (in 2007) because of lack of suitable pre-existing windspeed and ground motion instrumentation networks.  

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Caribbean Insurance Pool Not Affected by Hurricane Dean

INSURANCE JOURNAL

By David McFaddenAugust 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.

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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.)

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2nd 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.

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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.

Outputs

Event Rates

Probabilistic Hazard Module

Industry Exposure Database

RMS RiskLink

Wind speed by Windstorm Calculation Location and event, averaged to

CRESTA level

Industry insured loss by Event, with detail by CRESTA and LOB

Paradex-EUWS

Index Table

Results

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Eurowind Index - Historic Performance

Date Windstorm Name Region ImpactedParadex Europe

Windstorm 8.0 Index Value

Annual Occurrence Exceedance Probability

of Index Value

25th Jan 1990 DariaSouthern England,

Netherlands, Belgium and Germany

€12,208bn 1.82%

15th Oct 1987 1987JSoutheast England and

southeast Norway€5,180bn 6.37%

25th Dec 1999 LotharFrance, Germany,

Switzerland€6,732bn 4.52%

25th Feb 1990 VivianNorthern Scotland,

Scandinavia, Belgium€5,164bn 6.40%

18th Jan 2007 Kyrill Northern Europe €3,298bn 10.86%

Daria was the most severe of a series of events that moved into Europe in early 1990. 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

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But existing stations fail during hurricanes

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0

10

20

30

40

50

60

8/11 8/12 8/13 8/14 8/15 8/16 8/17

Win

d S

pee

d (k

nots

)

Time

NOAA Station: METAR KORL

Existing stations are often deactivated during hurricanes

There is “survival bias” – stations that survive are the ones that experienced weaker winds

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• 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

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Designing a privately financed windspeed recording network for Florida

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Earthquake recording in Japan

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Second Generation Paradex earthquake

zipResidential

indexvalue

f(0.3sec, 1.0sec, 3.0sec )

Comml & Ind

indexvalue

f(0.3sec, 1.0sec, 3.0sec )

zip

pre-compiled index value lookup tables

SA0.3sec, SA1.0sec, SA3.0sec

zip centroid SA values

Advanced NationalSeismic System

& partner networks

ShakeMap

(interpolate)

parametricindustry

loss indexvalues

zone

Res C&I

(zip < zone < state)

Paradex-EQEvent Bulletin

Initialset-up /update

IndustryLoss

ELT by zip & LoB

?

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New instrumentation

Discolored activatedindicatorsprovide 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?

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Low tech solutions have also been employed for 2nd 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

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What can Governments and MLF Agencies do to foster parametric risk transfer?

2nd 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 !

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