IRDA Seminar, Hyderabad

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IRDA Seminar, Hyderabad March 13,2006
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From a Study of the Airline Industry.. Performanc
e during wakeful period
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Airline Crashes
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• Micro Sleep cannot be controlled !

Just after passing the Outer Marker I fell
asleep and awoke at 300 feet above
threshold (anonymous report from a British
Captain)
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What Causes Accidents ?
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Story No. 2..
Quote from an Executive, extolling the benefits
of cutting quality assurance and inspection
costs The Company has established new global
benchmarks for the generation of exceptional
shareholder wealth through an aggressive and
innovative program of cost cutting on its
production facility. Conventional constraints
have been successfully challenged and replaced
with new paradigms appropriate to the globalised
corporate market place. Through an integrated
network of facilitated workshops, the project
successfully rejected the established
constricting and negative influences of
prescriptive engineering, onerous quality
requirements, and outdated concepts of inspection
and client control. Elimination of these
unnecessary straitjackets has empowered the
project's suppliers and contractors to propose
highly economical solutions, with the win-win
bonus of enhanced profitability margins for
themselves. The facility shows the shape of
things to come in unregulated global market
economy of the 21st Century."
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the production platform
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25th March 2001
the shape of things to come?
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Petrobras 20.03.2001P36 platform, Campos Basin
Petrobras P-36

• platform sank after suffering three explosions
• Insured claim PD 500 mio US (only PD)

• Operating difficulties not reported
• Down-sized, Out-sourced, Cost-cutting operations
• Flawed risk analysis
• Flawed crew training
• Flawed communications

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Story 3Closer home

• extract from an international risk surveyors
  2003 report on an oil platform-gt A major
  release of gas from a riser. could result .an
  explosion-gt Alternatively, riser failure
  could result in a jet flame that would cause
  severe damage
• Recommendation.The risers .. are unfortunately
  on the outside of the jacket envelope ..
  specifically require protection against boat
  impact riser protection guards have been placed
  where boat operations are envisaged but it is
  recommended these be reviewed to determine if
  impact . could be catastrophic

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Story 3Aug 2005

• extract from loss adjusters first report
• . it is reported that the vessel impacted with
  the platform and, in particular, the helideck of
  the vessel struck the jacket in the area of the
  risers in the south west corner.
• . loss reserved at 350 mn (PD)

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• Rating of Property Engineering Risks in a
  Detariffed Environment

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We will look at..

• -gt important aspects of risk management
• -gt assessment of natural perils exposures
• -gt rate determination, i.e. from risk premium to
  risk rate
• -gt risk rate loadings
• -gt some features of project insurance

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• Risk Management, Risk Management and Risk
  Management

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The Dynamic of Incident Causation
near miss
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The Dynamic of Incident Causation (2)
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Comprehensive Safety Management
Safety culture


Liveware
Risks
Interactive
Software
Hardware
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Summing up of information
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Assessment Matrix for Refineries and
Petrochemical Plants
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Expanding the BoxesExample .. Process control

• control systems
• building protection
• alarm

• number, spread

• emergency block valves
• pump seal types, doublemechanical seal

• emergency shut-down system
• fired heater controls
• flare system
• alarm systems hard-wired

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Expanding the Boxes (2)Example .. Management

• maintenance
• inspection
• contractors

• training
• procedures
• permit systems
• safe work practices

• HAZOP studies
• self-auditing
• incident analysis, reco control
• emergency procedures

• housekeeping, order
• safety policy
• safety culture

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Assessment Matrix for Refineries and
Petrochemical Plants
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Relative Inherent Risk (RIR) vs. Protect Level
(PL)
A Challenge for the Detariffed marketMultilocati
on Multi-occupation risks in one account
All locations showed in the graph above would
most likely have been described as average
risks although their RIR vs PL relationships are
quite different. The full use of the RIR vs PL
landscape allows for an enhanced separation
between risks showing different risk profiles and
hence for a better risk selection by the UW.
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A final word.know your abbreviation

• MPL Maximum Possible LossMPL Maximum Probabale
  LossMPL Maximum Potential LossPML Possible
  Maximum LossPML Probable Maximum
  LossMAS Maximum Amount SubjectMML Maximum
  Monetary LossNML Normal Monetary LossNML Normal
  Maximum LossNLE Normal Loss ExpectancyLLP Large
  Loss PossibilityLLP Large Loss
  ProbabilityELLP Expected Large Loss
  Poss.ELLP Estd Large Loss ProbabilityEPML Estd
  Probable Maximum Loss

• EPML Estd Possible Maximum LossMFL Maximum
  Foreseeable LossUML Ultimate Maximum
  LossAML Absolute Maximum LossTPL Total Probable
  LossTPL Total Possible LossMLE Maximum Loss
  ExpectancyAS Amount SubjectPS Percent
  SubjectVS Value SubjectLE Loss
  ExpectancyLE Loss EstimationEML Estimated
  Maximum Loss

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• Assessment of Natural Perils Exposures

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Underwriting natural catastrophe perils

• Features as distinct from fire losses
• ? low frequency / high severity
• ? accumulation control necessary (per
  peril and exposed area)
• ? company solvency is threatened if commitments
  exceed ability to pay losses
• ? full coverage may not be available
• ? high deductibles may be considered necessary
• ? insurance coverage may be prohibitively
  expensive, or in soft markets, exposure may
  be forgotten and insufficient premium
  charged

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Underwriting natural catastrophe perils (2)

• For example, earthquake -gt
• 1. What exactly is covered? (shock only? fire
  following? BI?)
• 2. Is premium sufficient?
• 3. Are deductibles high enough to eliminate
  numerous (costly!) smaller losses?
• 4. Is there a sublimit or co-insurance for the
  cover?
• 5. Is building construction shock resistant?
• 6. What is the seismicity of the area? Are
  coastal regions exposed to tsunami?
• 7. Is accumulation strictly controlled?

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Example.. Flood risk topography
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Basics of Cat risk assessment. a reinsurers
approach

• Basic approach quantification of (1) hazard, (2)
  insured value distribution, (3) damageability,
  and (4) effects of cover conditions
• India-specific approach above four model
  components can be quantified for India (e.g.
  Indian EQ activity, Indian EQ-insured value
  distribution, damageability by EQ of Indian
  risks, EQ cover conditions applied in India)

Hazard
Vulnerability
Value Distribution
InsuranceConditions
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Example Vulnerability, Storm
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Example Damageability
-gt for differentoccupancies
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Cat perils models needed

• Low frequency, many years with low losses or even
  no losses, but one year with very big, disastrous
  loss
• Burning costs analysis (as applied for e.g. fire
  peril or mortality) is not applicable
• Cat models simulate the EQ or W/F loss history
  over a very long time period (e.g. 10000 years).
  
• By summing up all the losses at the end of this
  time period, and dividing this sum by 10000
  years, the average yearly loss for EQ or W/F can
  be derived. Likewise, event losses are sorted
  according to their size and the 500-, 100-year,
  etc loss levels can be defined.
• annual expected loss can be drilled down to
  single risk level
• gt move from a zonal (EQ) or country (cyclone)
  rate to location specific rates for natural
  perils exposures.

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sample
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How about Engineering Risks?

• Engg-specific features for project risks
• -gt TSI exposed towards the end of the project .
  for eg. assume an avg exposure of 50 of TSI?
• -gt lower vulnerability as compared to property
  risks . the more vulnerable fittings and
  installations are added towards the end of the
  project
• For Annual Engg risks. - depends on
  coverage - assume lower exposure say 80 if
  adequate info is available

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Underwriting natural catastrophe perils a
dynamic scenario

• Structural changes which affect cat exposure
• ? growth of world population
• ? more concentration of people / values in
  exposed areas
• ? increasing use of exposed areas (coasts,
  flood plains)
• ? increasing standard of living
• ? introduction of complex and fragile
  technology
• ? changing building standards (enforcement)
• ? broadening scope of cover and deteriorating
  conditions
• ? global warming?

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Underwriting natural catastrophe perils future
uncertain?

• Global Warming? signs of trouble
• ? global surface temperature increased by
  ?0.6C during 20th century
• ? another increase of ?1.4 - 5.8 C projected
  for 1990 - 2100
• ? probably without precedent for the last
  10,000 years
• ? evidence that most warming during the last 50
  years is attributable to human activities
• ? man-made climate change will persist for
  centuries
• source Summary for policy makers (www.ipcc.ch)

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Underwriting natural catastrophe perils future
uncertain? (2)

• Global Warming? potential consequences for
  property (re-)insurers
• ? more extreme precipitation events (flash
  floods) likely
• ? more heat waves likely
• ? increase in tropical storms in some areas
  likely
• ? possible increase in storm severity and
  frequency
• ? potential increase in loss figures also
  affected by demographic and socio-economic
  change, as well as by technological advances
• ? in spite of the uncertainty involved, climate
  issues must be taken seriously!

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Underwriting natural catastrophe perils future
uncertain? (3)

• Natcat Pool ?

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• Setting the risk rate

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Premium

• must pay ? claims
• ? loss adjusting costs
• ? reserves (for losses with
  low frequency and the unforeseen)
• ? a contribution to the Insurers overheads
  and capital costs
• ? reasonable profit (hopefully)
• adjustments fluctuation, data quality
  inflation underlying changes portfolio,
  law, etc
• Developing appropriate rating starts with
  detailed loss statistics.

ExpectedLoss Cost
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Expected loss costscomponents

• The expected loss cost must encompass the annual
  average of ALL losses (frequent and infrequent)
  that may incur as a result of the contractual
  obligations.
• Types of losses to be considered
• Small and frequent losses basic loss ratio
• Large and infrequent individual losses large
  loss loading
• Large and infrequent event losses affecting many
  risks Cat loading
• All components together form the expected loss
  costs

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Assessment methods for estimating expected loss
costs

• Two main assessment methods
• Experience rating calculation of expected loss
  based on the loss experience of the past and its
  projection in the future.
• Exposure rating calculation of expected loss
  based on risk exposure (e.g. sums insured, number
  of risks, risk size distribution)

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Portfolio analysis

• Portfolio / Rating Analysis
• (whole property portfolio, material
  damage/business interruption, occupancy/etc)
• A companys analysis of its own figures will give
  the most relevant information. Some national
  market associations provide members with market
  (or tariff) info.

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A credibility approach to rating

• A credibility coefficient would account for-gt
  premium volumes-gt heteogeneity of portfolio-gt
  fluctuation of loss ratios from year to year

Example Metals Risk Category, Fire Credibility
Rates
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Deductibles

• Purpose ? encourage prudence by the
  insured (in addition to the duty of due
  precaution) ? reduce insurers claims
  burden ? reduce insurers administrative
  costs
• Discounting for deductibles
• ? may not be justified at all on a poor
  account ? should be based on a companys own
  statistics ? a company should be able to
  calculate (by occupancy, protection) what
  portion of its loss burden would be
  removed by which deductibles and discount
  its rates accordingly ? only makes sense if
  the original gross rates are
  adequate!!

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Setting natural catastrophe deductibles

• ? adequate loss statistics may not be
  available
• ? rating/deductibles based on theoretical
  models
• ? information on historical return periods
  may be thin
• ? will depend on the size of the portfolio
• ? is often subject to undue market pressure,
  especially during a period without
  catastrophic losses (memory is
  short)

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Individual risk adjustments (/-) for
QualityConstructionProtectionFire LoadRisk
Mgt.
ConditionsMPLDeductibleLoss Limit
NatCatQuality,AgeConditions
CoverageFLEXAPolitical risksMisc.
risksEndorsementsMach. b/d
BIFixed CostsNet ProfitDeductibleCBI
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Contingent Business Interruption

• A challenge to underwriting management because of
  
• expanded BI exposure
• underwriting is once removed from the risk
• potential lack of transparency
• insufficient information
• possible concerns of the insured about
  confidentiality
• another type of contingency planning analysis
• potential accumulation exposures with other
  business
• pricing difficulties

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Contingent Business Interruption - continued
CBI is by nature a non-transparent product!
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Contingent Business Interruption - continued
Interdependencies aviation industry
Steel and aluminium industry
Transport
Foundries
Chemicals
Fuselage
Engine
Wings
Gearing
Coatings
Electronics

Assembly
Components
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Engineering industry
Textile industry
Ceramics (breaks)
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• Risk Rate Loadings

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From the Risk rate to the Gross Rate
Short-term profit
Long-termProfit
Technical Premium
CapitalCosts
Production Cost
RealisedPremium
InternalCosts
Underwriting Cost
ExternalCosts
Risk Premium
ExpectedLoss
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Internal Target
Agreed withclient
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Do we chase the price cycle?or, attempt to
manage it?

• long-term target
• pre-defined profit to be achieved over the cycle
  in order to achieve a long-term return on equity
  target
• short-term target
• profit to be achieved according to current years
  business plan

Short-term price level
Long-term price level
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Short-term price level
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Capital CostsThe Investors perspective

• When assessing the profitability of the companys
  activities, the cost of holding capital to
  support the business must be considered
• The capital necessary to support insurance
  business is the frictional capital and is in
  excess of the base capital which is needed to
  support the investment portfolio
• But how much capital is needed to support the
  insurance business (capital adequacy) ?
• gtrisk-specific capital cost helps in assessing
  line profitability as well as performance
  measurement

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Capital adequacyrisk-adjusted capital
1st key question is the available capital
sufficient to absorb an adverse year and continue
business afterwards ? 2nd key question what is
an adverse year ?
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Definition of an adverse year shortfall as a
risk measure

• Shortfall is a down-side risk measure (other
  down-side risk measures are EML, MPL, PML,
  500-year loss, etc.)
• The 100-year shortfall represents the difference
  between the expected result and the average
  adverse result with a frequency of less than once
  in one hundred years
• Shortfall can be taken as a risk measure to
  define the loss potential in an adverse year

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Capital adequacyrisk-adjusted capital

• The shortfall for the companys underwriting risk
  can be determined using an integrated risk model
• It is then a management decision how much capital
  is additionally put aside to support the UW
  business
• This total capital then defines the risk-adjusted
  capital (RAC)

integrated loss distributions
individual loss distributions
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Capital adequacyexternal views from a global
perspective

• Regulators view required capital is defined
  through solvency and statutory capital
  regulations
• Rating agencys view required capital is defined
  through own rating-agency-specific risk models

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Exposure Rating

• Used for excess of loss rating, may be
  increasingly relevant under detariff as clients
  seek loss limit covers
• this is only a tool to determine layer premiums
  or deductible credits but does not substitute
  underwriting

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• Project Insurance, briefly

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Challenges in underwriting a single project risk
(1)

• Multiyear period (2-10 years, sometimes more)
• Many insured parties contractors/subcontractors,
  designers, manufacturers (often unknown) owner
• Multiline cover MD ( DSU), TPL, (marine)
• All risk, tailor-made wordings
• Insured perils construction/erection, testing,
  manufacturers risk incl. guarantee, natural
  perils, FLEXA, SRCC/malicious, etc.

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Challenges in underwriting a single project risk
(2)

• Plant/construction existing only on plans
• Exposures are difficult to assess in advance
• construction phases (permanent change)
• temporary stages and conditions high exposures
  (fire, flood, etc.) construction method may be
  new
• management and workforce quality, change
• environment often not well known
• first running of machines (new technology?)
• No loss history available

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Challenges in underwriting a project insurance
portfolio (3)

• High capacity required (cost of capital)
• Large risks are very heterogeneous (type,
  composition, characteristics, location)
  portfolio is unbalanced
• Risk and claims to be managed during all years
  until insurance periods expire
• No cancellation or change of conditions
• Portfolio subject to economic fluctuations
• New risks to be added every year to replace those
  expiring and provide minimum balance
• High acquisition and management costs
• Bad performance world-wide during last years

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Possible perils of a project

• Faulty design
• Faulty material
• Faulty workmanship
• Moral hazard

• Suppliers performance
• Off takers performance
• Contractors performance
• Contractors insolvency

• Natural perils
• Fire explosion
• Handling/Operation
• Construction

• Nuclear disaster
• Transport (marine) failure

• Riot, strike, civil commotion
• War
• Terrorism

• Defects
• Force majeure (environment)
• Breach of conditions
• Alterations/betterments

• Reliability of feasibility study
• Projects performance
• Price Fluctuations (commodity price)

• Expropriation
• Change in law
• Foreign law legal system
• Political instability violence

• Currency interest rate fluctuation
• Inconvertibility of currency
• Disabled currency transfer

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Typical progress of a project
Project Phases
Pre-project Development Construction
Testing Operation
Time Period
Variable 2-3 years 1-5 years 6 months
upto 20 yrs or more
Activities
Initial Develop. Feasibility study Site
work Startup, testing Commercial
Operations Identify a project Partner
Search Fabrication Provisional Punch list
acceptance Request for Form
project co. Errection Final authorisation
acceptance Go ahead approval Financing Mai
ntenance negotiations Design Transfer
(BOT) Bid, Liquidation procurement
Pre-development Development Constructions Commiss
ioning Operating exp.costs costs
expenses costs adjustments expenses Financing
costs Fuel Maintenance
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Revenues
None Recoup from partner Develop. Fees Operating
Revenue Operating revenue Equity sell
down
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the project buildup -------?
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• Thank you for your attention !

IRDA Seminar, Hyderabad March 13,2006