November 5th, 2012

GC Capital Ideas Top Stories: October 2012

Posted at 1:00 AM ET

1. Risk Profile, Appetite, and Tolerance: Fundamental Concepts in Risk Management and Reinsurance Effectiveness: Prior to the recent turbulence in the financial markets, insurers and reinsurers were increasing their use of enterprise risk management to make risk and capital management decisions. While this was driven in part by rating agencies and regulators, many carriers began to recognize the value of metric-based frameworks and capital models in evaluating their portfolios.

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2. Comparing Solvency II Standard Scenarios for Windstorms with Catastrophe Model Outcomes - Updated Study: With the generalized use of catastrophe models to measure the natural catastrophe exposure of insurance portfolios, the outcomes of these models have more and more influence in the determination of reinsurance needs. With the introduction of the Solvency II regime, the decision on reinsurance purchase should also be an integral part of a company’s risk management process. Specifically, an important consideration is the impact of reinsurance contracts on the Solvency Capital Ratio, a key decision metric of the risk management process. This process is not always easy when the probable maximum losses (PMLs) derived by the cat models differ from the standard European scenarios under Solvency II for calculation of the Solvency Capital Requirement for cat risk (SCRCat).

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3. What is the Reserving Cycle? Reserve releases have helped support financial results in the face of significant catastrophe losses in recent years. There are nevertheless indications that reserve redundancies will soon run out even though the sector continued to benefit from reserve releases on a calendar year basis in 2011. Figure 1 shows how calendar year redundancies have been a feature of earnings for a composite of 26 large U.S. P&C carriers since 1995.

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4. Update: Sandy: As always, our immediate thoughts and concerns are with those directly affected by Sandy, both in North America, and across the Caribbean. Many areas along the East Coast, and the Caribbean, bear signs of unspeakable consequences from this historic storm. The death toll in North America is now at least 55 (including one in Canada), in addition to the 67 who died in the Caribbean last week.

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5. Thailand Flood 2011: Executive Summary: In 2011, Thailand experienced its worst flooding in years, leaving more than 800 people dead and causing severe damage across northern and central regions of the country. The floods, lasting a few months, severely damaged and disrupted manufacturing operations in Thailand. Flooding also forced seven huge industrial estates in central regions to close, causing damage to the industrial sector in the billions of U.S. dollars. It is interesting to note that prior to 2011, none of the industrial parks in Thailand had been flooded over the past 40 years.

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6. Risk Preference Function - Embedding Risk-Reward in Capital Allocation: Capital allocation decisions are among the most important decisions made by company management. Through our own research and thought leadership and our observance of best practices at clients around the world, Guy Carpenter’s Enterprise Risk Management Advisory practice has compiled a set of leading practices around capital allocation for (re)insurers.

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7. Baden-Baden Reinsurance Symposium Considers the Opportunities and Threats Created by Volatility: Guy Carpenter hosted “Volatility - Opportunity or Threat?” the Reinsurance Symposium held in Baden-Baden on October 21. The event examined how volatility is viewed within the insurance and reinsurance sectors, particularly from a financial perspective, and explored the potential which market turbulence can generate.

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8. Model Suitability Analysis (MSA)SM - Own Your View of Risk: The quantification of catastrophe risk through the use of numerical models is accepted routine in our industry. Given the large impact of catastrophe risk on (re)insurance portfolios it is no surprise that the methodologies used for such quantifications are becoming the subject of more intense scrutiny by regulators and risk managers. Whether the motivation is internal, external or both, efforts are now in full swing towards acquiring a deeper understanding and a more sophisticated use of catastrophe risk model results - the path to “own your view of risk.”

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9. Capital Models - What Lies Beneath: A robust capital model can be a great tool to help run a (re)insurance business. It is a given that capital models rely on a huge wealth of assumptions, and it is the quality of these assumptions that determine how useful the model is. There is an emphasis on those assumptions that are explicit, for example, catastrophe model outputs, premium rates and reserve volatility. But there is another type of assumption - that which is implicit. These assumptions can have a very material impact on the model results.

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10. Cold Spots Heating Up: Executive Summary: The succession of costly and global catastrophe losses over the last few years has had a wide-ranging impact on the (re)insurance sector. Since 2010, (re)insurers have been hit by powerful earthquakes in Chile, New Zealand and Japan, while devastating floods also caused widespread damage in Australia and Thailand. The exceptional cluster of global natural catastrophes in 2011 in particular emphasized increasing risk in emerging markets. The result has been unexpectedly expensive ‘cold spot’ losses in areas that were not considered as risky in the past.

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