Reinsurers should expect catastrophe losses like 2011 every 15 years: AIR Worldwide

by Artemis on January 16, 2013

A new report published today by risk modeller AIR Worldwide suggests that insurers and reinsurers should be prepared to face insured catastrophe losses of the magnitude seen during 2011 every 15 years. Insured losses from global natural catastrophes exceeded $110 billion in 2011 which AIR said is a 6.7% exceedance probability, so a near 7% chance, of seeing that level of losses in a single year, according to its global industry exceedance probability (EP) curve.

An exceedance probability of just under 7% equates to a 15 year return period suggesting that the insurance, reinsurance and indeed catastrophe bond market, must be prepared to face loss years akin to 2011 more regularly than perhaps has been thought. The 2011 insured catastrophe loss toll was the second highest on record and the year saw 15 individual events which cost the re/insurance industry over $1 billion.

AIR’s report says that despite the magnitude of 2011’s insured losses no single company became insolvent as a result, which it says is testament to the improved approach to catastrophe risk management aided by the use of catastrophe models. We would also add that it is testament to the capitalisation of insurers and reinsurers helped in no small amount by convergence sources of reinsurance capacity in the cat bond, ILS and collateralized markets.

The report from AIR Worldwide, titled Taking a Comprehensive View of Catastrophe Risk Worldwide, looks at the 2011 loss year and also examines scenarios which could cause much larger global insured losses. As an example AIR look at the 1% exceedance probability loss, which equates to the 1-in-100 loss year (return period) which it says is $206 billion. It’s easy to see how an active hurricane season, combined with some other major global events on the scale of 2011’s, could reach that level of insurance industry loss. The report also looks at the average annual loss year, of which 2012 appears to qualify, as AIR estimate the average to be $59 billion while 2012 saw $58 billion according to estimates.

“Many in the industry were surprised at the aggregation of losses in 2011, especially since we didn’t have a major U.S. hurricane,” commented Bill Churney, senior vice president, AIR Worldwide. “However, AIR’s models incorporate years with losses much greater than what we experienced in 2011. This is the real value of having a credible catastrophe model — to fully anticipate possible outcomes, including future catastrophes and future years that will produce losses exceeding any historical amounts.”

The report also looks at a more remote loss year probability of the 250 year return period, or 0.4% aggregate exceedance probability, which it says corresponds to a $265 billion loss. The report looks at various modelled catastrophe event scenarios and discusses the exceedance probability, return period and corresponding insured losses that could be expected.

“Despite the significance of the toll in 2011, insured losses fell well within the range for which global insurers and reinsurers should be prepared,” continued Churney. “It’s our hope that the report will help companies increasingly concerned about escalating levels of loss to better understand and own their risk.”

The takeaway here is to be prepared and to ensure that your reinsurance and retrocessional protections are structured in such a way as to protect you from the return periods that threaten your portfolio of risk. The catastrophe bond and collateralized reinsurance markets have a role to play in making capital available for high return period events, which is where these instruments are often deployed to greatest effect.

The ramifications of a 100 year return period annual loss of $200m to the insurance and reinsurance industry would surely include impaired catastrophe bonds, potentially some companies struggling and reinsurers, retrocessionaires and collateralized capacity providers all facing meaningful losses. How the third-party capital sector of the reinsurance market would react is hard to predict, but such a loss year would force renewal rates upwards meaning that for investors serious about reinsurance and catastrophe risk as an asset class there would be an opportunity to recoup losses.

You can access the full report from AIR Worldwide here.

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