Designing Parametric Risk Contracts Using Catastrophe Risk Models

1
Designing Parametric Risk Contracts Using
Catastrophe Risk Models

• Dennis E. Kuzak
• Sr.Vice President, EQECAT, Inc.

2
Agenda

• Introduction to Parametric Insurance Contracts
• Description
• Advantages and disadvantages
• Parametric Triggers and Parametric Index Triggers
• Example-Australis Ltd.
• Reporting Agencies for Caribbean Contracts
• Hypothetical Country Contract
• Country Map
• Designing a parametric index
• Post event determination of loss

3
Parametric Insurance Contracts

• Financial contracts vs. traditional indemnity
  insurance
• Physical measurement of the loss parameter
• Highly correlated with expected physical damage
  (e.g. peak gust wind speed)
• Subject to probabilistic analysis
• Sufficient historical data to construct
  statistical or simulation based risk model
• Independent recording of event parameter

4
Parametric Triggers

• Advantages
• Simplicity
• No Disclosure/Exposure Data.
• Transparency
• Moral Hazard
• Rapid Settlement
• Disadvantages
• Basis Risk
• Regulatory

5
Parametric Triggers

• Quake in a box Tokyo Marine-1997 and
  Concentric Ltd (Tokyo Disneyland) 1999
• Payoff based on earthquake magnitude gt Magnitude
  JMA occurring within a region defined by boxes
  or circles
• Simple to understand
• Rapid settlement- 30 to 60 days max.
• Considerable basis risk- poor correlation between
  loss and loss recovery

Parametric Re
Concentric Ltd.
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Parametric Index Triggers

• Why were they created?
• Existing parametric triggers have unacceptable
  basis risk
• How do they reduce basis risk?
• Select physical parameter highly correlated with
  damage/loss
• Multiple measurement (grids) locations in close
  proximity to risks
• Use weighting factor at each location to
  recognize vulnerability and value distribution

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Example- Australis Ltd (2006)

• Securitization of Australian Cyclone (hurricane)
  and Earthquake Risk for Swiss Re
• Parametric index for cyclone and earthquake risk
• Cyclone risk for NE Australia and earthquake risk
  for entire country
• Cyclone risk uses peak gust wind speed,
  earthquake uses intensity scale (0-12)
• Earthquake reporting agency Geosciences
  Australia
• Cyclone reporting agency Joint Typhoon Warning
  center

8
Australian Earthquake Calculation Locations
9
Weight Distribution of Cyclone Calculation
Locations
10
Hurricane Reporting Agency

• The National Hurricane Center (NHC) is a branch
  of the Tropical Prediction Center (TPC), under
  the National Oceanic and Atmospheric
  Administration (NOAA). NHC maintains a continuous
  watch on tropical cyclones over the Atlantic,
  Caribbean, Gulf of Mexico, and the Eastern
  Pacific from May 15 through November 30. The
  Center prepares and distributes hurricane watches
  and warnings for the general public, and also
  prepares and distributes marine and military
  advisories for other users.
• The NHC's Preliminary Reports contain
  comprehensive information on each storm,
  including synoptic history, meteorological
  statistics, casualties and damages, and the
  post-analysis best track (six hourly positions
  and intensities).

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NHC Best Track Report
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Earthquake Reporting Agency

• National Earthquake Information Center (NEIC)
  created in 1966 as part of US Geological Survey
• Rapidly determines location and magnitude of
  significant earthquakes in US and worldwide
• Collects data through operation of national and
  global seismograph network of over 3000 stations
• Reports locations and magnitude via
• http//www.neic.cr.usgs.gov/neis/bulletin/bulletin
  .html
• Quick Determination of Epicenters (QED) - daily
• Preliminary Determination of Epicenters (PDE)
• Weekly and monthly

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Hypothetical Country Contract
3 Tourism
1 Port and manufacturing
2 Capital
4 Tourism
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Creating a Parametric Index

• Compile physical and financial data for the
  country
• Aggregate exposures at each calculation location
• Using hurricane model, calculate physical damage
  loss exceedance (LEC) curve
• Estimate catastrophe funding deficit from reduced
  taxes and emergency response efforts as a of
  physical damage.
• Calculate funding deficit loss exceedance curve
• Create parametric wind index ( based on gust wind
  speed) which is equivalent to the funding
  deficit LEC

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Creating a Parametric Index
Probability
Damage LEC
0
.2
.4
.6
.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
Loss ( Billions)
Catastrophe Deficit LEC
Probability
Wind Index LEC
Contract Amount 40 xs 40 M
Index Layer Attach 2000
Index Layer Exhaust 4000
Loss ( MiIlions)
Wind Index
1000
3000
5000
7000
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Post Event Loss Determination

• Obtain Hurricane parameters from the National
  Hurricane Center
• Calculate wind speed at each of the four
  locations
• Calculate wind index at each location
• Sum the four values to calculate event index
• Loss recovery ((Event Index- attachment)/Layer)
  contract amount

17
Hurricane path and calculated wind speeds
3 Tourism (95 MPH)
1 Port and manufacturing ( 125 MPH)
2 Capital (130 MPH)
4 Tourism ( 145 MPH)
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Wind Index
i4
0.00005502 ? ?i wi ? (vi 30)4
i1
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Index Calculation and Loss Payment