Comparing Solvency II Standard Scenarios for Windstorms with Catastrophe Model Outcomes – Updated Study: Part II
Benchmarking QIS5 Scenario Return Period against Vendor Models
Our analysis supports the fact that losses in the QIS5 windstorm scenarios are often within the range of the major vendor models. But how do return frequencies compare? The QIS5 standard scenarios are tailored to represent a 200 year return period in each territory. Looking at the QIS5 loss estimate on the modeled exceedance probability curves reveals the corresponding modeled return period. Plotting the implied vendor model return frequencies against the QIS5 scenarios’ 1-in-200 year level yields an interesting (albeit similar) spread, as shown in Table 1.
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Illustrated above are return period levels (logarithmic scale from the center) of Solvency II standard scenario wind losses and vendor models’ return periods of the same loss amount. Both are based on PERILS Industry Database by country. EU represents the scenario for all countries combined after diversification.
As seen with Model A in most countries, the lower exceedance probability curve in this vendor model leads to lower frequencies - higher return periods for a given loss level.
Reinsurance Structuring Implications
While the Level II Implementation Measures are still discussed, it is assumed most companies will have to use the standard formula in the short to medium term even if they have opted for an internal model.
For defining and structuring reinsurance programs to cover catastrophe events, most of the companies are referring to the outcomes from one or multiple vendors’ models. This is a market practice that is also requested to support the transactions with the reinsurers.
The parallel run between the standard formula and cat model vendors will be challenging in countries where the outcomes from one or multiple models diverge significantly from the standard scenario. This divergence is leading insurers to review the adjustments needed to define their risk management position and optimize their positioning and operations under the new capital regime.
The final selection of the reinsurance capacity to purchase will benefit from a good understanding of why the cat modeling calculations show different results. It will support the process many companies are undertaking to develop and document their own view of cat risk. The final decision on the reinsurance capacity to purchase will be based on the appreciation of how the different models, including the standard formula, are better adjusted to model the exposure of each company.