HowCatastropheandFinancialModellingRevolutionisedthe.pdfVIP

How Catastrophe and Financial Modelling Revolutionised the Insurance Industry David Simmons: Managing Director, Capital, Science and Policy Practice London: 14th March Catastrophe Reinsurance Pricing The “Traditional” Model  Catastrophes are, by their nature, rare events  Before the “modelled age” pricing was based upon recent loss history and required return  Pricing at near return period dictated by recent history (burning cost)  Pricing at far return periods set by minimum return requirements (minimum rate on line)  Concept of “the bank” and “payback” prevailed  When loss occurred reinsured was in effect calling in their “bank” of premiums paid in clean years  If bank insufficient then rates in future years increased so that reinsurer was paid back over a fixed time period  But these arrangements were non-contractual, market practice only  Result was that catastrophe reinsurance pricing was very reactive  When losses occurred prices increased steeply  In period of no losses prices tended to drift down due to market pressure  Exacerbated by tendency for some reinsurers to exit post-loss and new entrants emerge when rates are high 2 Catastrophe Reinsurance Pricing 1990s UK Catastrophe Example  Catastrophe Market in 1990 was already stressed  Large “1 in 100” windstorm loss in 1987 - 87J – USD 3.1m (original values per Munich Re)  Other market losses: Piper Alpha and Hurricane Gilbert (1988), Hurricane Hugo Exxon Valdez tanker (1989) tested catastrophe and specifically the Lloyd’s market  Storm 90A or Daria in January caused insurance losses event greater than 87J – USD 5.1m  Followed by a series of other smaller storms including Vivian in February costing USD 2.1m  In 1991 UK catastrophe prices reinsurance