The Road Ahead

Earthquake Response: Lessons from Japan

Tragic disasters like the earthquake that hit Japan earlier this year serve as a reminder of why our industry exists.

The tragedy in Japan also showed the difference that planning and preparation can make. Japan is a world leader in understanding perils and had plans and prevention measures in place. Those measures undoubtedly helped save lives and Canada can learn some lessons.

As a nation and as an industry, we have to expect the unexpected. January’s ‘The Great British Columbia Shake Out’ is the type of disaster planning that can help reduce the consequences of a quake strike in Canada. More than 420,000 people participated in that earthquake drill. The event was held on the 311th anniversary of the largest quake in Canadian history – a Magnitude 9 quake that hit B.C. in 1700. We can do more to educate people on what they should do in that kind of situation today.

Swiss Re also sees ways for the public and private sectors to work together to ensure the best response should a major earthquake hit Canada.

The financial cost of natural disasters has increased five-fold over the past 30 years – from an annual average of $25 billion in the 1980s to $130 billion in the decade leading up to 2010. Economic development, population growth and a higher concentration of assets in exposed areas each have contributed to this dramatic increase.

At the same time, the financial capacity of the public sector to deal with new burdens is severely strained. Swiss Re has a global partnerships team that delivers innovative risk financing solutions to governments to help them get back on their feet quickly following a natural catastrophe.

This strategy has been successful in other areas of the world. The Caribbean, for example, has been hit by a number of major natural disasters in recent years. In addition to the suffering caused by these events, regional governments had to confront the challenge of financing recovery. This not only included expenses for relief activities in the aftermath of the event, but also the medium- to long-term impacts of lower tax revenues, economic revitalization costs and reconstruction.

The World Bank began to look for a mechanism that would enable an effective response to future catastrophic events. The solution, launched in 2007, was the Caribbean Catastrophe Risk Insurance Facility (CCRIF), of which Swiss Re is a partner.

The CCRIF is the first multinational parametric insurance facility. It is set up like a captive, owned and operated by Caribbean governments. The parametric insurance policies it issues to the region’s governments provide quick payouts, based on wind speed and seismic activity.

In June this year, the Microinsurance Catastrophe Risk Organisation (MiCRO), of which Swiss Re is an integral part, announced the release from Swiss Re of a large round of parametric insurance proceeds in Haiti following major rainfall in the south of the country. The rains resulted in widespread flooding, mudslides and loss of life, but the quick payout helped with the rescue, recovery and rebuilding efforts.  

These types of solutions are now being successfully implemented in developed economies as well. Last July, Swiss Re completed a parametric insurance transaction with the state of Alabama in the United States, the first time a government in an industrialized country has used such solutions.

Changing Regulatory Focus

Following the global financial crisis, international regulators have increased their focus on risk, both in terms of mandating that insurers have appropriate risk management frameworks as well as adequate capital.  European entities are moving closer to Solvency II implementation, and the United States is moving toward implementation of the Dodd-Frank Act.

Similarly, OSFI’s recent and upcoming changes have a strong risk focus. The new reinsurance guidelines, issued at the end of 2010, outline more formal requirements for ceding companies to assess their current reinsurance program – including counterparty exposure, contract provisions and contract enforceability. In addition, companies are required to obtain a legal opinion regarding their rights to collateral offered by unlicensed reinsurers in order to continue to take capital/asset credit.

In proposed changes to the Minimum Capital Test (MCT) ratios for 2012, insurance companies will have additional capital requirements to the extent that they have interest rate or foreign exchange mismatches. There are also changes in the factors that need to be applied for both assets and collateral based on the rating and term to maturity. The market should expect a continued focus on risk-based capital testing in future years, with measures including updating the shock factor to be applied to interest rate mismatches, as well as potentially updated factors for equity risk and catastrophe risk.

P&C companies have recently been required to complete the 2011 round of sensitivity testing, with stress factors being applied to interest yields, credit default assumptions (for both assets and reinsurance exposure), equity and real estate values, small catastrophe events and stagnant premium growth. OSFI has indicated these stress tests will continue in the future.

Also, on June 17, OSFI issued their guideline on internal target capital ratios, requiring an internal target capital ratio that considers an insurer’s risk appetite and risk profile.

The regulatory and industry focus on risk underlines the need for insurers to have appropriate models or methods for assessing their various risk exposures, as well as fulsome consideration of various risk mitigation strategies in both the near and long-term future. These strategies will likely involve elements of changing asset mixes, increasing or implementing hedging programs and increased or different use of reinsurance.