Management of “evolving regional catastrophe risk” is fundamental part of insurers’ strategies, says Ernst & Young

Corporations, insurers and reinsurers now realise that the likelihood of natural disasters is greater than they had previously thought, according to Ernst & Young (EY) Actuarial Services partner Russel Lok and senior manager William Liang.

Lok and Liang say that although co-insurance and simple excess of loss reinsurance have historically been used to manage underwriting capacity, insurers now need to review their natural catastrophe exposure and evaluate whether they have sufficient and appropriate reinsurance cover.

EY’s 2013 Asia-Pacific insurance outlook points out that although reinsurance is used extensively in mature insurance markets, many insurers in developing markets baulk at buying catastrophe reinsurance. However, the report claims that the increasing frequency and severity of natural catastrophes are forcing more insurers in the region to cede additional risk to reinsurers.

Singapore-based Liang says that, in an effort to improve insurers’ enterprise risk-management practices, many local insurance regulators are urging companies to establish and state clearly their risk appetite regarding a wide range of risks.

“Regional nat cat risk is an important element of the insurance risk for many general insurers and reinsurers, and companies will therefore become more conscious of the need to purchase the right level and type of reinsurance so their net exposure to catastrophe losses is actually consistent with their risk appetite,” he says.

Commercial property

Commercial property insurance is a good example of an area that needs more focus, says Liang. “While the impact of catastrophe on the property-damage element is quite apparent and immediate, it is actually quantifying the contingent business interruption losses that is much more challenging,” he says.

“But this is very important because often these losses turn out to be much more than property-damage losses. That needs to be incorporated into the modelling.”

Liang says risk professionals must understand both the value and limitations of catastrophe modelling for the effective management of risk. “For example, some vendor catastrophe models have their limitations in addressing risks such as tsunami, flood, business interruption losses, disruption to supply chains, and so on,” he says.

“Such limitations are quite important to point out to those who rely on the outputs of these models.”

Refining models

Lok says insurance and reinsurance companies interested in continuous improvement are now looking at refining their models, and will feed this into pricing and products. “It’s probably going to take a while to settle on which is the best model – maybe that will never be answered – but having discussion around the models has got to be good for improving the overall science of insurance,” he says.

“The fact that there are these models out there with people debating them is good because it prompts people to think about it. It raises the sophistication of the industry.”

Lok says the trick is to use all the information available, including modelling, to “extend the scope of what people had previously thought was possible”. “Good risk managers will make the right call between the speculative and the potential,” he says.

“A skilled risk manager will think, ‘OK, everyone talks about Thai floods, but do they talk about Vietnamese floods?’. They are clever enough to say, ‘Did you see what happened in Thailand? Well, Vietnam is similarly exposed’. But how best do you quantify this appropriately?”