OSFI - Earthquake

Question 1

What are the best practices for earthquake modeling? (1-4)

Answer 1

• DOCUMENT use of the model within risk management program
• explain why a particular model is used versus ALTERNATIVES
• QUALIFIED STAFF needed to run in-house models regularly
• must have KNOWLEDGE of Assumptions, Methods, Limitations of the model

Question 2

What are the best practices for earthquake modeling? (5-7)

Answer 2

• provide evidence to show that the granularity and quality of the DATA is appropriate
• understand how UNCERTAINTY affects the capital adequacy and the reinsurance requirements
• if PML(model 1) <> PML(model 2), explain the differences, and mention the subsequent model adjustments (where PML = Probable Maximum Loss)

Question 3

What are the 5 key principles for managing earthquake exposure?

Answer 3

1) Risk management
2) Data management
3) Models
4) PML (Probable Maximum Loss)
5) Financial resources and contingency plan

Question 4

What is the broad 3-point plan for managing earthquake exposure?

Answer 4

• MEASURE
• MONITOR
• LIMIT EQ EXPOSURE

Question 5

Briefly describe the key principle of RISK MANAGEMENT for EQ exposure.

Answer 5

EQ exposure Risk Management policies are SUBJECT TO OVERSIGHT by the Board of Directors and IMPLEMENTED by senior management.

Question 6

Briefly describe the key principle of DATA MANAGEMENT for EQ exposure.

Answer 6

• data required is MORE than for traditional ratemaking

- must address the INTEGRITY, VERIFICATION, LIMITATIONS

Question 7

Briefly describe the key principle of MODELING for EQ exposure.

Answer 7

One must understand the assumptions, the methods, and the limitations of the EQ models.

Question 8

Briefly describe the key principle of PML (Probable Maximum Loss) for EQ exposure.

Answer 8

PML = Total Expected Ultimate Cost

- includes considerations for data quality, non-modeled exposure, model uncertainty, and multi-region exposure

Question 9

Briefly describe the key principle for FINANCIAL RESOURCES & CONTINGENCY PLAN for EQ exposure.

Answer 9

• Financial Resources: quantification of how financial resources cover PML (Probable Maximum Loss)
• Contingency Plan: how to continue efficient business operations after a disaster

Question 10

Identify uses of EQ models aside from PML (probable Maximum Loss) calculation. (2)

Answer 10

• assist in U/W decisions

- monitor exposure accumulation

Question 11

What are sound practices for EQ model VERSION? (4)

Answer 11

• use more that 1 model
• ensure timely updates of material changes to the model (within 1 year of the change)
• understand the assumptions, methods, and limitations of the vendor software for PML (Probable Maximum Loss) calculation
• if in-house PML model is used, one should compare the results to alternate models

Question 12

What are sound practices for EQ model VALIDATION? (3)

Answer 12

• compare modeled losses with actual losses
• compare tail losses with market price for reinsurance
• use global data to supplement limited Canadian EQ data

Question 13

How might management adjust for low data quality in an EQ PML (Probable Maximum Loss) estimate?

Answer 13

They may add a margin of safety to the PML estimate (though, this is not an excuse to ignore the data quality).

Question 14

Identify non-modeled exposures when calculating the PML (Probable Maximum Loss). (4)

Answer 14

• exposure growth between the date of data and the relevant exposure period
• consider the adequacy of the ITV (Insurance-to-Value)
• consider GRC (Guaranteed Replacement Cost), may be inadequate due to inflation
• increased seismicity after a large event

Question 15

Identify 2 examples of model uncertainty.

Answer 15

• uncertainty associated with conversion from location-specific ground motion to actual damage levels
• model assumptions are being continuously updated & refined

Question 16

How might management adjust for model uncertainty in an EQ PML (Probable Maximum Loss) estimate?

Answer 16

They may add a margin of safety to the PML estimate.

Question 17

Regarding multi-region exposures, identify disadvantages of using the maximum of BC & QC exposures. (2)

Answer 17

• understates the risk for insurers that have exposure in both regions
• ignores that there could be EQs elsewhere (than BC or QC), which could be material

Question 18

How should PMLs (Probable Maximum Loss) be reported for Canadian versus foreign insurers with exposure outside the of Canada?

Answer 18

BoD (Board of Directors), Senior management would report the PMLs to OSFI as follows:

• Canadian insurers would report PMLs based on worldwide exposure
• foreign insurers report PMLs based on Canada-wide exposure

Question 19

Identify financial resources for covering PML for EQ exposure. (4)

Answer 19

• capital & surplus (max of 10%)
• reinsurance (most insurers use CAT reinsurance)
• EQ reserves (calculated as part of MCT)
• capital market financing

Question 20

Identify a restrictive condition on EQ exposure financial resources for: reinsurance coverage.

Answer 20

When including a non-CAT reinsurance, one must consider the ‘per event’ limits and other events exhausting the coverage.

Question 21

Identify a restrictive condition on EQ exposure financial resources for: capital market financing.

Answer 21

OSFI prior approval is required before recognition as a financial resource (under MCT guidelines).

Question 22

How is a particular insurer’s EQ risk management program failing the key principles? (3)

A PandC insurance company is exposed to EQ risk through it’s operations in BC; however, it has struggled with finding an accurate and consistent way of quantifying this risk. Several measures, including PML, have been used, but the results have varied significantly from one year to the next. This concerns senior management, as they are unsure that the company’s financial resources would be sufficient in the event of a severe EQ.

Answer 22

DATA: may be thin since Canadian EQ events are rare
MODEL: may not have sufficient understanding of the assumptions, methods and limitations of the models
PML (Probable Maximum Loss): may not be considering non-modeled exposures

Question 23

Identify ways to improve risk estimation & CAT risk management for a particular insurer? (4)

A property and casualty insurance company provides earthquake insurance to their insureds
and considers purchasing a catastrophe treaty. However, it has struggled with finding an
accurate way of quantifying earthquake risk. Earthquake simulation model results show that
the probability of a catastrophic event is extremely low.

Answer 23

• tech investments
• audit the data
• ensure adequate financial resources & contingency plan
• measure/monitor/limit EQ exposure

Question 24

What are OSFI’s EQ exposure reporting requirements?

Answer 24

• to file an EQ Exposure Data form annually

- if no material exposure, then submit a letter stating so

Question 25

What are OSFI's EQ exposure supervisory requirements?

Answer 25

If an insurer has material EQ exposure: - the insurer must submit EQ risk management policies - it must also submit a DCAT report that includes an EQ exposure scenario (or provide a reason for not including such a scenario)

Question 26

What is the difference between OSFI's EQ exposure reporting and supervisory requirements?

Answer 26

- Reporting: just submit the standard EQ Exposure Data form | - Supervisory: must submit comprehensive risk management policies

Question 27

What are OSFI's supervisory options when an insurer's EQ exposure risk management principles are not being followed?

Answer 27

OSFI may adjust the capital or asset requirements or the TSR (Target Solvency Ratio).

Question 28

What are the duties of senior management regarding EQ exposure risk management? (3)

Answer 28

- implement the risk management plan and internal controls - discretion to increase the PML (Probable Maximum Loss) from the model due to low data quality OR model uncertainty - provide an annual declaration to the BoD (Board of Directors)

Question 29

What is contained in the senior management annual EQ exposure declaration to the BoD (Board of Directors)? (2)

Answer 29

- state the status of compliance with the risk management policies (except where noted) - explain the calculation of the PML (Probable Maximum Loss) with details of supporting financial resources

Question 30

What are the duties of the BoD (Board of Directors) regarding EQ exposure management?

Answer 30

They are responsible for the oversight of the risk management plan & ensuring adequacy of internal controls.