Risk Is Opportunity

EXPOSURERisk Is Opportunity

04 THE NEXT BIG ONE Navigating the protracted soft market

10 EUROPEAN FLOOD Understanding flood risk correlations

16 GROWTH STRATEGIES How exposure management tools can assist Foreword

Contents Welcome to the first edition of Exposure, the new RMS publication on catastrophe and risk management practices.

Exposure complements our Horizons series, now 4 The next big one? in its sixth edition, which provides, more in-depth What's needed to transform the reinsuance cycle coverage of RMS research and development insights. Both publications represent a continuation of our commitment to an informed market empowered by 6 U.S. coastal flood: Rising up the agenda objective data and science-driven models provided with the highest levels of openness and transparency.

In this edition of Exposure, we focus on the theme 8 The next step in convergence that risk is opportunity. Now more than ever, the market is seeking to avoid surprises, improve business performance and innovate to create new opportunities 10 Spatial correlation, risk and opportunity: Europe flood for growth. At RMS, we are pleased to offer an expanding range of solutions to ensure a vital and growing risk and insurance industry. 12 Accounting for extra-tropical transitioning of typhoons in Japan The industry is truly at an inflection point. In the years to come, I am confident we will look back at this era of rapid change and see a time when 14 In-house catastrophe models offer many benefits the industry seized the moment to innovate and increase its relevance. Most of the world is under- for Solvency II or uninsured. Rapid changes in globalization have introduced new risks and created new imperatives to increase resiliency. Shifts in the structure of our 16 Beware the private catastrophe: Managing exposures economies, from assets to networks at risk, digital and otherwise, are creating new demand that can and must be met by the talent and capital within 18 Learning from New Zealand to avoid surprises the market. And technology, data and analytics are transforming what is possible to achieve. 20 How can insurers help drive the resilience I hope you find this edition of Exposure a valuable resource as you continue to improve your risk analytics revolution? capabilities and model risks into opportunities for your business.

Hemant Shah President, CEO and Co-Founder RMS, Inc. The next big one?

Rather than waiting for the next elusive hard market, successful (re)insurers are focusing on making informed underwriting decisions and taking well-calculated risks, according to Ben Brookes, vice president of capital markets.

A popular topic of conversation at protracted soft market, in addition to A surprise event is the one you don't the big industry gatherings is when excess capacity and heightened com- see coming and is the one most likely the next "big one" will occur. What petition within the reinsurance sector. to change the market. Given the size and nature of loss could reverse quickly evolving nature of emerging the softening trend and see a return At the time of writing, and approaching risks such as cyber and pandemic, to hard market pricing? The influx of the peak of the 2016 Atlantic hurricane in addition to more traditional perils, alternative capital into the reinsur- season, the National Oceanic and such a loss could arise from numerous ance market over the past decade has Atmospheric Administration (NOAA) sources. Increasing insurance penetration transformed the traditional reinsurance revised its annual forecast, increasing in emerging markets has increased the cycle with no guarantee a market peak the probability of an above-average assets-at-risk of natural catastrophes will follow the current trough. season from 30% to 35%. NOAA expects and the potential for major losses from the 2016 season to be the most active regions that have been traditionally Insured catastrophe losses over the hurricane season since 2012. However, regarded as "non-peak." past few years have been signifi- forecasts are just forecasts, and there cantly below average, particularly in is significant doubt over whether a "It therefore appears 5 comparison to major loss years such U.S. hurricane on its own could turn as 2005 and 2011. The majority of the market – particularly because U.S. increasingly unlikely the large-scale events during this time hurricane is one of the best-understood industry will again see have resulted in a relatively low level and well-modeled perils, making this a a market adjustment in terms of the structural integrity of the market, it also means Initiatives such as the RMS(one) platform aim to make it of insurance claims due to the fact they scenario the market can manage. reinsurance companies are faced with the prospect that easier for (re)insurers to establish and institutionalize global, have occurred in areas where insurance on the scale that was current soft market conditions will continue to prevail and customized views of risk, as well as lowering the barrier for penetration is low. Commenting on the 2016 hurricane last witnessed in 2001 are, in essence, the new normal. implementing and deploying self-developed probabilistic forecasts, Mark Powell, vice president and 2005 due to the models. "There is significant of product management for RMS In such an environment, risk selection and risk-adequate HWind, said, “I fully expect activity to industry's fundamentally pricing are all-important, and there is very little margin for Driving value out of these model output-based decisions doubt over whether a ramp up by Labor Day, we are all geared altered capital structure." error. Competition in the reinsurance space is now a race will be the main differentiator as reinsurers navigate and U.S. hurricane landfalling up to assimilate into HWind, real-time to broaden insurance coverage, searching for new business make sense of the new reinsurance environment. One such on its own could turn measurements from the Air Force and Given the way in which the industry in new territories and risk classes, rather than a race to the opportunity, discussed later in this magazine, is the ability NOAA hurricane hunters as well as has changed and the ability of capital bottom with reinsurers competing on price alone. to understand the "spatial correlation" of European flood the market – particularly several satellite remote sensing to move quickly into the industry post- risk in order to gain a diversification benefit and make quick because U.S. hurricane observing platforms. We're also focus- event, even a major shock or series of Modeling, data and analytics offer a competitive advantage and strategic M&A decisions by analyzing exposure data in is one of the best- ing efforts on reconstructing iconic shocks may not have the same impact to those reinsurers that use them to make informed decisions real time. historical hurricane landfall events to on the reinsurance cycle that it did in and take informed risks. Underwriters are scrutinizing understood and well- provide insurers with observation-based the past. Insurance-linked securities model output more than ever before, overlaying their own In a market coming to terms with this "new normal" of lower modeled perils, making hurricane wind footprints.” (ILS) fund managers continue to line assumptions and risk tolerance and looking for unexpected margins, but serving an increasingly important role in creat- this a scenario the market up capital ready to be deployed the correlations between books of business to avoid being ing a safer society through broader coverage, the importance What we do know is that market- minute there is any indication of price disproportionately impacted by any one event, and avoiding of effective catstrophe risk quantification and management can manage." changing events are often surprise hardening. the private catastrophe. has never been greater. losses, revealing unknown accumula- Recent frequency of North Atlantic tions lurking in reinsurance portfolios. It therefore appears increasingly unlikely The ability to customize and blend multiple models allows hurricanes, typically a significant driver Historical examples included Hurricane the industry will again see a market users to tailor the models to their own view of risk, and Ben Brookes is vice president of RMS Capital of insurance industry catastrophe losses, Katrina's ability to overcome the defenses adjustment on the scale that was last complement and build on the insights from sophisticated Markets. He also leads the design and development has been below average, with last in New Orleans and the 9/11 terrorist witnessed in 2001 and 2005 due to the exposure and accumulation management techniques, with of the ILS portfolio management functionality in year's record El Niño one factor behind attacks on the New York World Trade industry's fundamentally altered cap- increasingly real-time views of portfolio risk. RMS(one)®. the low number of tropical cyclones. Centers. ital structure. While this is a good thing These conditions have resulted in a

EXPOSURE / RMS.COM coast. Here, where many FEMA high-risk flood zones (A and V) are located, NFIP participation ranges from 10 percent to 70 percent, Advice to (re)insurers looking to grow a according to RMS. It is also an area for which model vendors coastal flood portfolio have developed a number of advanced flood analytics, from probabilistic models to hazard data, both of which provide a U.S. coastal flood: Collect high-quality, flood-relevant exposure more comprehensive view of the coastal flood risk landscape data. and enable private carriers to quantify coastal flood risk more accurately. • Knowing precise location and elevation information, such as distance to coast and Probabilistic storm surge models are widely available in the the agenda the presence of local flood defenses, is Rising up market today. Often integrated with a broader hurricane or wind just as important as knowing the structural model solution, they provide frequency, severity and uncertainty profile. metrics for a spectrum of potential coastal flood events, helping to inform more accurate portfolio management, reinsurance • Having important elevation information, such pricing and risk transfer decisions. as the height of the lowest occupied floor or the threshold flood height, helps determine At a time when the U.S. property catastrophe sector is experiencing heightened competition, flood Flood hazard metrics, on the other hand, are newer to the insurance offers untapped potential that can benefit (re)insurers, the government and emergency the approximate water level needed to cause market. They provide varying views of flood extent and severity management organizations, explains RMS flood risk expert Jeff Waters. damage to the property. throughout the U.S., depending on the provider. In many cases they represent hazard on a more granular basis than is currently Understand the correlation between surge possible using FEMA maps, enabling carriers to differentiate Opportunities begin at the coast, where In 2005, Hurricane Katrina caused $15 the Risky Business Initiative to quan- and other types of coastal hazards, and how it risks within flood zones with more precision and accuracy, and storm surge-driven coastal flooding billion in economic storm surge losses tify and publicize the economic risks translates to policy terms and conditions. determine where FEMA may be over- or underestimating flood stimulates the majority of the flood in Orleans Parish alone, which includes of climate change in the U.S. Among hazard in a given location to, ultimately, select (or avoid) the risk • Hurricane wind and surge impacts are often risk profile. Using a variety of newly the city of New Orleans. It was the first other findings, the study determined vis-à-vis the NFIP. For example, the recently released RMS U.S. available flood tools, probabilistic time in decades that over 50 percent that by mid-century, storm surge has correlated; knowing where and to what Flood Hazard Data provides defended and undefended views models and location-level analytics, of losses from a hurricane were driven the potential to generate more than extent can help you avoid overconcentration of flood hazard extent and severity for multiple return periods, private carriers can quantify coastal by storm surge. Levee and flood wall half of economic losses from landfall- of risk. reflecting all sources of both coastal and inland flooding. flood risk accurately, allowing them failures caused flooding across 80 ing hurricanes in the U.S. • Tropical cyclone-induced precipitation can to determine the size and extent of percent of New Orleans, devastating also drive a significant amount of damages As the private flood insurance market continues to take shape, opportunities and where to capitalize much of the city and costing the The U.S. flood opportunity – it along the coast. enhanced flood analytics can be used to gain important insights on them. insurance industry $41 billion (at 2005 starts on the coast into potential flood events before they occur, particularly along the 7 prices) in catastrophe claims. coast, allowing (re)insurers to be more proactive than reactive The movement towards privatizing Know the potential future impacts of large- Coastal flood is a unique peril due to scale climate and exposure patterns. when developing, managing and growing a profitable flood its complex hydrodynamic character- the U.S. flood insurance market reflects portfolio. Success will, however, depend largely on the ability "According to RMS concern surrounding the flood "protec- istics and highly granular gradients. • By mid-century, storm surge is expected to of the market to quantify flood risk with sufficient granularity research there is more tion gap" and the unsustainability of The magnitude and severity of U.S. generate more than half of the economic and to offer actuarially sound rates that allow (re)insurers to the National Flood Insurance Program coastal flood risk is dependent on a than $11 trillion in losses coming from landfalling U.S. obtain a profitable return. number of factors, including the shape (NFIP), which has amassed more than exposure in coastal ZIP hurricanes. of the coastline, local bathymetric and $23 billion in debt by offering cover- topographic profiles, slope and elevation. codes from Texas to age at rates that do not reflect the • With sea-level rise comes an increased true underlying risk. This is especially From a (re)insurer's perspective, it's Maine." likelihood for catastrophic surge events, Jeff Waters is responsible for guiding the insurance true in highly exposed coastal zones, also highly dependent on building especially in coastal cities with shallow market's understanding and usage of RMS North where it is estimated that as much as 20 characteristics, such as first-floor Storm surge was once again a major sloping coastal profiles (Tampa, FL). America climate models, including the hurricane, percent of NFIP flood insurance rates elevation or presence of flood driver of loss during Superstorm Sandy severe convective storm and winter storm models. defenses, as well as flood coverage in 2012. The pulse of seawater pushed are subsidized. conditions and exclusions. ashore by the storm's hurricane-force winds flooded streets, tunnels and Unlocking the potential for flood privat- In the U.S., the majority of the coastal subway lines in New York City and ization nationwide will depend on a Figure 1. Current and projected 100-year return period economic storm surge losses. flood risk profile is driven by storm surrounding areas, causing insured number of factors, from federal and surge from tropical cyclone events. losses of nearly $19 billion, 60 percent state-level legislative reform to the Consequently, the most susceptible of which was attributed to coastal implementation of more actuarially NEW NEW areas are located along the Gulf flooding. sound rates. It may take years before MIAMI TAMPA the private flood market is mature, but 1-in-20 1-in-290 ORLEANS 1-in-20 YORK 1-in-20 Coast and Eastern Seaboard, where 1•30 1•30 1•45 1•45 the foundation is taking shape and 1-in-60 1-in-320 1-in-60 1•45 1-in-60 exposures are high and distance to Surge risk is only going to increase 1•65 1•315 1•75 1•80 the coast is low. According to RMS in the future. Risk and corresponding opportunities are materializing. 1-in-100 1•90 1-in-350 1-in-100 1-in-100 1•125 1•345 research, there is more than $11 trillion losses from hurricane-induced storm 1-in-140 1-in-380 1•380 1-in-140 1•130 1-in-140 in exposure in coastal ZIP codes from surge are expected to grow as a result In the meantime, it is important to 1-in-180 1-in-410 1-in-180 1-in-180 Texas to Maine, especially in the last of sea-level rise and increasing coastal recognize where private carriers can 1-in-220 1-in-440 1•440 1-in-220 1•200 1-in-220 10-15 years. exposures. In 2014, RMS partnered with begin to assess and capitalize on these opportunities today – the hurricane

(Source: RMS)

EXPOSURE / RMS.COM The next step in convergence

Stephen Moss, director in the RMS capital markets group, explains how traditional reinsurers, recognizing that third-party capital provides an opportunity rather than a threat, are opting to build or buy their own insurance-linked securities (ILS) fund management capabilities.

The property catastrophe reinsurance Last year saw a 3.5 percent reduction cedants a broader array of risk transfer industry has undergone a rapid trans- in traditional capital dedicated to rein- tools while tapping third-party capital. formation over the past decade as surance, down $13 billion to $357 billion capital from institutional investors has according to Willis Re, reflecting the Aspen, Everest Re, Hannover Re and flooded into the sector. Attracted by challenging operating environment Munich Re were among those who solid returns and an asset class that is and record volume of M&A activity significantly increased sidecar capital in uncorrelated to their other investments, among other drivers. The reduction recent months; there was also marked access to the track record, underwriting into other classes of business. One looks set to continue. In April, ILS investors steadily increased their was offset by the continued growth in growth in managed fund capacity expertise and catastrophe modeling trend for the collateralized reinsurance publication Artemis noted that the allocations to ILS. At the same time as non-traditional capital, which hit new by Hiscox (Kiskadee Re), Validus Re and analytics know-how of the parent market is its growth outwards, both launch of the RMS® Marine Cargo and the resulting demand for product has heights of $70 billion. (AlphaCat) and Lancashire (Kinesis) company, while the parent company by territory and line of business. The Specie catastrophe risk model would 9 intensified, collateralized reinsurance among others. Some have sought to gains access to considerable capital ability to apply catastrophe models and provide an enhanced approach to has overtaken catastrophe bonds as Opportunity or threat? access third-party capital by investing not held within its own balance sheet. exposure management tools in this bid marine risk quantification, helping the dominant source of ILS capacity. in existing players, with Leadenhall's More progressive reinsurance compa- for diversification is becoming a key ILS investors and capital to increase increased stake in Amlin, Markel's nies recognize this non-traditional Reinsurers are also able to target differ- differentiator for ILS funds. participation in the marine insurance As this institutional capital flooded into acquisition of CATCo and Endurance's capital is here to stay and the opportu- ent business through their third-party and reinsurance market. the peak zones of Florida wind, California acquisition of Blue Capital (as part of nities it presents if properly harnessed. management capabilities. Generally, earthquake and Japanese wind and its acquisition of Montpelier Re), as "The ability to apply There are signs that some of the While dedicated ILS funds still dominate pure ILS funds prefer "cleaner", modelable earthquake, traditional reinsurers initially recent examples. catastrophe models and independent funds are recognizing the market in terms of assets under business, whereas a tradtional reinsur- felt displaced. Excess capital, several the great benefit of having in-house management, in recent years more ance company has access to the whole exposure management years of benign catastrophe losses Managed fund capacity arguably catastrophe modeling and analyt- reinsurers have sought to leverage market. and differing risk and return appe- combines the best underwriting with tools in this bid for diver- ics capabilities, opting to license these opportunities, setting up their tites among the so-called "alternative" the most efficient forms of capital in sification is becoming a reinsurance catastrophe models or hire own dedicated ILS funds, sidecars or However, a reinsurer-owned fund is capital has heightened competition and the markets where it is deployed. The reinsurance talent from markets such special purpose syndicates to offer able to leverage the parent company's key differentiator for ILS as Lloyd's and Bermuda to bolster their eroded rates-on-line. collateralized reinsurance platforms have existing infrastructure, access to business funds." and its suite of risk management and offerings. Capital growth for dedicated ILS funds and reinsurer Third-party reinsurance capital volume ($B) pricing tools in order to offer some- Lancashire's Kinesis Capital, for The boundary between the traditional third-party capital managers thing that is different from some of instance, has been set up as a multi- reinsurance market and ILS arena will the independent ILS funds. class, fully collateralized reinsurance continue to blur in the coming years as 50,000 $80 Col Re provider covering specialty classes market players seek to combine the 45,000 Col ILW This is attractive to investors, particularly $70 such as marine among its product best underwriting – and modeling and 40,000 Sidecars those looking to diversify away from $60 offerings, albeit backed by a strong analytics expertise – with the most 35,000 Bonds property catastrophe peak perils $50 analytical approach. And the trend efficient form of capital. 30,000 25,000 $40 20,000 $30 15,000 $20 10,000 Stephen Moss leads strategic and business development activities for the the RMS capital markets team, working $10 5,000 alongside bond deal teams and relationship managers to pursue new market opportunities and support ongoing 0 0 initiatives. 1999 2002 2005 2008 2010 2013 2010 2011 2012 2013 2014 2015 mulative AUM (at 2016 values $M) values 2016 (at AUM Cu mulative Year of manager launch (Source: Aon Securities)

EXPOSURE / RMS.COM Closing the protection gap "A bigger gap between economic The gap between economic losses and insured loss for flood and insured losses from the June events is a global issue. Each new major flood event further 2016 floods is expected in Germany stresses the need for greater insurance penetration around the Spatial correlation - world. than in France due to lower levels of flood insurance penetration." Europe is not immune from the issue. In markets where flood insurance is not bundled into standard insurance policies, such as risk and opportunity in Germany, adoption of flood cover is relatively low in comparison to markets like France, Spain and the U.K. While uptake increased marginally in the aftermath of the 2013 floods, there remains a significant opportunity to close the protection gap and improve the country's flood resilience – with models playing a key role.

The success of "nat cat" schemes in these markets is one mechanism According to Maurizio Savina and Adrian Mark, flood risk experts at RMS, as much as 80 percent of 1-in- with which the industry can assist governments to close the 200 year European flood losses that impact the (re)insurance industry result from Pan-European events. protection gap. The U.K.'s Flood Re initiative is one example of a Understanding the "spatial correlation" of countries more prone to simultaneous flooding is, therefore, public-private approach whose aim is to ensure residential properties essential in managing accumulations and identifying opportunities to diversify the risk in a portfolio. at a high risk of flood have access to affordable insurance, while lobbying for increased physical resilience through continued investment in flood defenses and mitigation measures. In June 2016, the severe floods that In fact, a quarter of major European managing their international portfolios. affected several European countries are flood events impact more than one Compared to Germany and the Czech Catastrophe modeling is essential to the future success of such expected to generate claims of up to $1.6 country. And floods simultaneously Republic, for other territories spatial schemes and to increasing Europe's flood resilience more generally. billion for the French market and around affecting at least three European correlation can be significantly lower, Risk transfer and risk mitigation require high-precision modeling $1.4 billion for Germany. This follows countries account for more than 90 offering (re)insurers opportunities to across Europe to better understand the impact of Pan-European Germany's record year for flood percent of tail risk across Europe. diversify their flood risk. flooding. But these tools can also be used to understand the losses in 2013, and a year when total These facts underscore the importance importance of investment in flood defenses and inform planning economic losses for flood reached of understanding the correlation and Figure 1, below, shows the spatial correlation guidelines in flood-prone areas. $16.5 billion across central and east- diversification of risk across both basins of flood risk between London and ern Europe, of which $4.1 billion was and countries in order to accurately all other parts of Europe. The red 11 insured. estimate portfolio accumulations and territories are highly correlated with capital requirements. London and thus more likely to be Those flood events demonstrate how hit by common events, with yellow- Managing flood accumulations multiple river systems can be affected, To further emphasize the point, RMS to-green areas not correlated with impacting more than one country, estimates that approximately 20 London and southern England. By RMS Europe Inland Flood High Definition (HD) and lasting for several days or even percent of the 1-in-200 year losses using this information a (re)insurer Models were developed to help the insurance weeks depending on regional meteo- arising from portfolios in Germany and with a portfolio concentrated in industry and policymakers better evaluate hydrological conditions. The underlying the Czech Republic are from events southern England could strategically the potential impact of Europe's flood events driver of such broad flooding is often that impact both countries at the same target expansion into central or eastern through an improved understanding of risk just a single weather system that time. This is a statistically significant Europe in order to grow its portfolio accumulations, ensuring a major event does produces heavy precipitation over level of spatial correlation, and a while minimizing accumulations of not have a disproportionate impact on a (re) multiple countries. consideration for (re)insurers when correlated risk. insurer's portfolio.

These models simulate hydrology continuously Figure 1. Spatial correlation of flood risk between London and other locations in Europe. in space and time to reproduce both temporal and spatial correlation of flood risk and offer the largest single Europe-wide event set available on the market, covering 18 river basins and 8,289 catchments over 13 countries. LONDON "Some neighboring countries sharing common river Negative Correlation basins are more likely to be Maurizio Savina is a senior product manager for the RMS Europe flood models. Positive impacted at the Correlation same time by a Adrian Mark is senior product manager for RMS flood maps and data. (Source: RMS Europe Flood HD Models.) major flood."

EXPOSURE / RMS.COM Accounting for extra- tropical transitioning

a b of typhoons in Japan Figure 1. Satellite imagery of Typhoon Shanshan (2006). (a) On September 16 this tropical cyclone was located to the north of Taiwan and (b) three days later it tracked north near Japan and the Korean peninsula having undergone extra-tropical transitioning. The difference in the cloud patterns reflects the difference in the wind field prior to and after extra-tropical transitioning. (This is an example of a left-hand side/comma ETT cyclone.) (Source: Image taken from MODIS, NASA.)

CFSR 10 m wind [ms-1] at 2002-07-16_12 CFSR 10 m wind [ms-1] at 2008-05-12_06 RMS has invested considerable resources in developing an advanced approach to explicitly model transitioning typhoons in Japan, writes Margaret Joseph, Asia typhoon product manager. The pioneering 30 work has helped to develop the most advanced Japan typhoon model on the market; one that makes allowances for the realistic patterns of typhoon wind and typhoon flood loss due to transitioning, which 15 25 are a major driver of typhoon wind and flood damage in Japan. 20

10 Not only have more than 50 percent of is initially a hybrid between a tropical time of year. Also, by being fully 15 Japan's landfalling typhoons either cyclone and an extra-tropical cyclone, coupled, the model represents the undergone or were undergoing and which may ultimately end up as impact of extra-tropical transitioning 10 5 extra-tropical transitioning, all Japan's a pure extra-tropical cyclone. This on precipitation, storm surge and wave largest insured loss-causing typhoons transitioning can significantly alter the through changes in the wind field. 5 had undergone or were undergoing shape of the wind field, increasing the 13 20 25 30 35 40 45 20 25 30 35 extra-tropical transitioning when they radius of maximum winds, shifting the While wind is a consideration, (re)- a 40 45 20 25 30 35 b made landfall. This includes Typhoon location of the strongest winds and, insurers must not ignore the flood 120 125 130 135 140 145 150 155 120 125 130 135 140 145 150 155 Mireille (1991), the costliest typhoon at times, shifting the maximum winds component of typhoon risk when to strike Japan – and Asia as a whole. from one side of the typhoon track pricing the risk and modeling portfolio Figure 2. Examples of extra-tropical transitioning typhoons showing (a) the right-side wind field (e.g., Typhoon Halong, 2002), (b) the The importance of understanding and to the other (Figure 1). Driven by the accumulations. Japan's geographical comma-shaped wind field with maximum winds to the LHS/RHS of the track (e.g., Typhoon Rammasun, 2008). (Source: RMS research.) accurately modeling transitioning is, underlying changes in the wind field, position in relation to the "average" therefore, plainly crucial for catastrophe extra-tropical transitioning impacts the typhoon track, has implications for modelers and for those who use such storm surge and waves of a typhoon, the flood hazard. As a typhoon tracks models for business. also affecting the precipitation patterns north, into the subtropics and mid- Margaret Joseph is a product manager for RMS Asia Pacific tropical cyclone models, including Australia cyclone, within a typhoon. latitude, it can interact with other China typhoon, and the forthcoming western North Pacific typhoon model. Understanding the weather systems and transition to an phenomenon While several generations of RMS extra-tropical cyclone. Storms that tropical cyclone models have included are transitioning or have transitioned Japan's geographical position, both its increasingly realistic representations of when they impact Japan can bring latitude and position under a strong extra-tropical transitioning, we have more intense precipitation and/or jetstream, make it very susceptible to recently concluded our largest body storm surge. While Japan has one extra-tropical transitioning typhoons. of research to better understand and of the world's most advanced flood RMS research in this area has been maximum winds can be located on Loridan, T., Khare, S., Scherer, E., Dixon, A transitioning typhoon tends to be the model transitioning, focusing more protection systems, a significant published in scientific journals both sides of the typhoon track; for M., & Bellone, E. (2015). Parametric strongest in terms of wind category at specifically on typhoons in the west- proportion of the country lies below one type of RMS-classified transitioning modeling of transitioning cyclone wind landfall, which has implications for a ern North Pacific. The peer-reviewed sea level. Consequently, if flood Using a combination of observed data the maximum winds can flip across the fields for risk assessment studies in wind-loss perspective. research has informed one of the and coastal defenses are breached, and numerical modeling studies, RMS typhoon track. the western North Pacific. Journal of numerous scientific advancements in widespread and severe flooding could modelers investigated the difference Applied Meteorology Climatology, 54, Extra-tropical transitioning occurs when the forthcoming RMS® Japan Typhoon ensue. in the shape and extent of the wind The research builds on work from Naoko 624–642. doi:http://dx.doi.org/10.1175/ typhoons in the western North Pacific HD Model. field in extra-tropical transitioning Kitabatake at the Meteorological JAMC-D-14-0095.1 track toward the pole where they inter- Overall, typhoon presents both a typhoons as compared to the wind Research Institute in Japan, involved act with mid-latitude weather systems The rebuilt typhoon model now includes significant risk as well as a growth field in the tropical phase. Additionally, work with Professor David Nolan of Loridan, T., Scherer, E., Dixon, M., Bellone, and the jet stream. If the impact of a novel parametric representation of opportunity for global (re)insurers. the RMS team classified different types the University of Miami, and has been E., & Khare, S. (2014). Cyclone wind field the interaction is small, then they typi- the wind fields that replicates the The RMS Japan Typhoon HD Model cally weaken, because of colder sea features specific to extra-tropical is designed to help users evaluate all of transitioning wind fields, with the reviewed by Professor John Knaff of asymmetries during extratropical transition surface temperatures. If the impact transitioning, including accounting these variables when considering their important implication that in extra- NOAA/NESDIS/STAR - RAMMB CIRA at in the western North Pacific. Journal of is stronger, then they may change for classifications that have a higher exposure to typhoon flood. tropical transitioning typhoons the Colorado State University and Professor Applied Meteorology Climatology 53, into a different kind of storm, which probability of occurrence at a given maximum winds are not restricted to Yukio Tamura of the Wind Engineering 421–428. doi:http://dx.doi.org/10.1175/ the right of the track. In fact, the Research Center in Tokyo. JAMC-D-13-0257.1 EXPOSURE / RMS.COM In-house catastrophe models offer many benefits for Solvency II

RMS senior director Laurent Marescot and Rohan Baxter, regulatory affairs manager for Europe, explain how bringing catastrophe models in-house to use in the internal model process offers a solution that better reflects a (re)insurance company's risk profile, providing a more informed and beneficial approach to managing risk and capital under Solvency II. SII benefits of embedding RMS Europe Windstorm Models

Under Pillar 1 of the Solvency II (SII) framework, (re)insurers Europe Windstorm Models and RMS® Europe Flood Models, One example of how RMS works to help clients move beyond Firstly, characterizing windstorm clustering has presented who are opting to use the standard formula to manage in-house – as opposed to only relying on the final modeled simple loading and develop more robust views of capital by far the biggest hurdle for modelers due to the scarcity of their risk-based capital calculations face potentially higher loss output. By doing so, firms make validating the model requirements is with the treatment of windstorm clustering. historical data on clusters with which to calibrate models. To capital requirements. In contrast, firms that develop their own easier since they can gain a far deeper understanding of tackle this, RMS worked with several academics to gather 15 internal model, integrated with external models and data, the models and the impact of uncertainty on their book of Windstorm clustering, which is when two or more cyclone more long-term data on storm clustering, helping to reduce have an opportunity to optimize their capital and increase business by having direct access to RMS modeling experts and events occur close together in space and time, is considered the uncertainty in the most recent RMS Europe Windstorm growth opportunities. engineers, the comprehensive suite of model documentation, by some of the large European regulators to have a significant Models release. In addition, while windstorm clustering and additional views of risk around model assumptions. (See potential impact on a company's balance sheet. As such, is a real and observed phenomenon, the RMS clustering To manage catastrophe risk calculations, for example, embed- the clustering example on the next page.) many firms are required to account for windstorm clustering model can be turned on or off. This more flexible choice not ding external catastrophe models into an internal model in their capital requirements. This means that the model- only enables firms to better understand model uncertainty can offer substantial benefits, including optimal Solvency Additionally, by bringing the RMS models in-house, firms ing community must provide meaningful transparency and through a deeper understanding of the key model assump- Capital Requirement (SCR) calculations. For instance, an may be able to have the models adjusted to reflect their validation of their clustering modeling methods and the tions around windstorm clustering, they can also directly embedded model can reflect exposure data quality and help own view of risk, overlaying RMS science with their own data data used. assess the potential impact on their book of business. identify areas of accumulation and diversification, as well and assumptions in a consistent way, moving beyond adding as capturing full risk mitigation measures for which firms simple loading factors to loss results. Models in-house also To ease the validation process for our clients and enable more are credited. The resulting capital savings can also enable a deliver the highest granularity of loss outputs, on demand firms to embed the RMS Europe Windstorm Models in their business to underwrite more profitable risks and make more all around the year. Being able to make better and more internal model processes, we have addressed the challenge profitable investments. timely decisions and testing the impact underwriting and risk of managing windstorm clustering. transfer decisions have on their capital requirements, as However, for catastrophe models of complex perils, such as required by the Own Risk and Solvency Assessment (ORSA) European windstorm or flood, where several key assumptions that lies at the heart of Solvency II, are additional advantages drive uncertainty, undergoing deep validation of the models to this approach. is essential. Should firms use any element of a catastrophe model, including model loss output, to inform their internal Solvency II uncertainty post-Brexit a feeling it would not result in for Solvency II will continue to model, regulators require that firms can demonstrate they significant changes for London- benefit U.K.-based firms as they have understood the assumptions and limitations of the Laurent Marescot leads product management for In the U.K., considered to be one of based reinsurers. strive to meet rating agency, model. the RMS Europe and Asia models. the most prepared markets for the investor and other stakeholder One option could be for the U.K. Rohan Baxter is the head of regulatory affairs for new regime, 19 insurance entities expectations. The best way for firms to address model validation in this to seek equivalence with Solvency Europe. had received approval for the use of II as it is home to roughly 11 While the journey in preparing situation is to bring catastrophe models, such as the RMS® a full or partial internal model under percent of undertakings currently for the regime has been far from Solvency II as of January 1, 2016, subject to the regime. Even if easy for many firms, enhanced including the Society of Lloyd's. At the U.K. ultimately does not enterprise-wide risk management the time of writing, the implications seek equivalence, the risk-based practices will benefit (re)insurers of the U.K.'s EU referendum were practices that have been developed whether they are inside or outside still being absorbed but there was the EU. EXPOSURE / RMS.COM their portfolios. According to Validus "Addressing unpredictability requires In specific regions for certain perils, chairman and CEO Ed Noonan, in that we change how Enterprise Risk firms' can use exposure-based analytics statements following Tianjin last year, Management programs operate," states to contextualize their modeled loss the private it is now "unacceptable" for the marine Sikich. "Forecasts are often based on results. This allows them to "what if" Beware insurance industry not to seek to a "static" moment; frozen in time, so on the range of possible deterministic improve its modeling of risk in complex, to speak.... Assumptions, on the other losses so they can stress test their ever-changing port environments. hand, depend on situational analysis and portfolio against historical benchmarks, the ongoing tweaking via assessment look for sensitivities and properly set catastrophe While events such as the Tianjin port of new information. An assumption expectations. explosions, Thai floods and more recent can be changed and adjusted as new Fort McMurray wildfires may have information becomes available." Exposure management occurred in so-called industry "cold analytics spots," the impact of such events can be "Best-in-class exposure evaluated using deterministic scenarios Best-in-class exposure management Having a poor handle on the exposure on their books can result in firms facing disproportionate losses to stress test a firm's book of business. management analytics analytics is all about challenging assumptions and using disaster relative to their peers following a catastrophic event, but is easily avoidable, says Shaheen Razzaq, This can either provide a view of risk is all about challenging where there is a gap in probabilistic scenarios to test how your portfolio director, RMS software. assumptions and using model coverage or supplement the would respond if a major event were view of risk from probabilistic models. disaster scenarios to test to occur in a non-modeled peril region. Such analytics can identify the pinch The explosions at Tianjin port, the floods as high as $3.5 billion, with significant some firms experiencing losses reaching how your portfolio would Although much has been written about points – potential accumulations both in Thailand and most recently the Fort "cost creep" as a result of losses from $275 million. The event highlighted respond if a major event Nassim Taleb's highly improbable within and across classes of business McMurray wildfires in Canada. What business interruption and contingent the significant accumulation risk to "black swan" events, in a global and were to occur in a non- – that may exist while also offering these major events have in common business interruption, clean-up and non-modeled, man-made events in interconnected world firms' increasingly valuable information on where to grow is the disproportionate impact of contamination expenses. large transportation hubs such as modeled peril region." must contend with the reality of "grey your business. losses incurred by certain firms' port- ports, where much of the insurable swan" and "white swan" events. It is clear Sikich's observations on folios. Take the Thai floods in 2011, an content (cargo) is mobile and change- "While events such as the unpredictability are becoming the Whether it is through M&A or organic event which, at the time, was largely able and requires a deeper under- According to risk consultant Geary new normal in the industry. Firms growth, having a better grasp of unmodeled. The floods that inundated Tianjin port explosions, standing of the exposures. Sikich in his article, "Are We Seeing are investing to fully entrench strong exposure across your portfolio enables several major industrial estates around Thai floods and more the Emergence of More White Swan exposure management practices across strategic decision-making and can add Bangkok caused an accumulation of Speaking about the firm's experience 17 recent Fort McMurray Events?" the definition of a grey their entire enterprise to protect against value to a book of business. The ability losses for some reinsurers, resulting in an interview with Bloomberg earlier swan is "a highly probable event with private catastrophes. They are also to analyze exposure across the entire in negative rating action, loss in share wildfires may have this year, Zurich Insurance Group chair- three principal characteristics: It is reaping other benefits from this type organization and understand how it is price and withdrawals from the market. occurred in so-called man and acting CEO Tom de Swann predictable; it carries an impact that of investment: Sophisticated exposure likely to impact accumulations and loss noted how due to the accumulation industry 'cold spots,' the can easily cascade...and, after the management tools are not just potential is a powerful tool for today's Last year's Tianjin Port explosions in China of risk that had not been sufficiently fact, we shift the focus to errors in designed to help firms better manage C-suite. Exposure management tools also resulted in substantial insurance impact of such events detected, the firm was looking at ways judgment or some other human form their risks and exposures, but also to enable firms to understand the risk losses, which had an outsized impact can be evaluated using to strengthen its exposure manage- of causation." A white swan is a "highly identify new areas of opportunity. By in their business today but also how on some firms, with significant con- ment to avoid such losses in the future. deterministic scenarios to certain event" with "an impact that can gaining a deeper understanding of their changes can impact their portfolio centrations of risk at the port or within easily be estimated" where, once again, global portfolio across all regions and – whether acquiring a book, moving impacted supply chains. The insured stress test a firm's book There is a growing understanding that after the fact there is a shift to focus perils, firms are able to make more into new territories or divesting a property loss from Asia's most expen- of business." firms can avoid suffering disproportionate on "errors in judgment." informed strategic decisions when nonperforming book of business. sive human-caused catastrophe and impacts from catastrophic events by looking to grow their business. the marine industry's biggest loss since Some of the highest costs from Tianjin taking a more analytical approach to

Superstorm Sandy is thought to be were suffered by European firms, with mapping the aggregation risk within

Shaheen Razzaq is the RMS Exposure Manager offers a comprehensive view of a product director for RMS business, giving senior executives access to fact-based insights Exposure Manager and works for agile decision-making. The "big data" platform, accessed via together with RMS clients to understand their overall needs RMS(one)®, provides a new way to visualize risk, offering for the RMS(one)® platform. real-time insights in both modeled and unmodeled peril regions. The flexible analytics can be complemented with any probabilistic analysis that exists for modeled peril regions, offering a consistent view of risk across the organization.

EXPOSURE / RMS.COM • The spatial extent of the observed liquefaction Innovation 1: New geospatial methods that map groundwater- during the February 2, 2011, M6.3 event corresponds well data and near-surface groundwater depth to better well to the shallow groundwater zones in the area of determine regions of high liquefaction susceptibility across Christchurch, but not where the groundwater is deeper. the country, including low-seismicity areas. Learning from New The observations confirm that groundwater depth is an important factor in predicting liquefaction initiation. Innovation 2: New geospatial methods that use site-specific liquefaction borehole data to create maps that delineate • There is significant spatial variation in the liquefaction- liquefaction initiation potential and severity parameters. related ground displacements over short distances. Zealand to avoid To account for these large differences in severity over Innovation 3: New methods of predicting where liquefaction short distances, the modeling methods need to map could result in horizontal displacement. liquefaction severity parameters for localized variations where possible. Innovation 4: New analysis of empirical building fragility to liquefaction based on the Christchurch observation data surprises • Two primary failure mechanisms cause the severe ground and insurance claims. displacements, predominantly vertical deformation as well as more laterally induced ground displacement. These important enhancements to the model's liquefaction loss component offer a more precise tool with which to • The Christchurch liquefaction data shows a probable gauge the likely impact of this secondary earthquake hazard correlation between ground displacement severity on a book of business by enabling firms to predict a more Secondary hazards, such as liquefaction, and the earthquake sequencing that hit the low-seismicity and damage. Lateral deformation is found to be more granular scale loss from liquefaction. The developments have area of Canterbury, New Zealand, in 2010 and 2011 contributed significantly to the overall loss figures, damaging than vertical displacement. improved how RMS earthquake models determine the spatial explains RMS seismology expert Megan Arnold. pattern of liquefaction initiation, the liquefaction severity Learning from the earthquakes using observational data at the ground surface (if initiated) and expected building and our own research, RMS incorporates four innovations responses to liquefaction-induced ground displacements. The phenomenon of "loss creep" has area, caused surprisingly widespread progressive damage during the 2010- in liquefaction loss modeling into the RMS® New Zealand long been an issue associated with damage, but no loss of life. This started 2011 Canterbury earthquake sequence, Earthquake HD Model to help firms better predict the major catastrophes, and slight revisions a sequence of 17 loss-causing earth- significantly confusing the loss picture occurrence and severity of liquefaction: in expected losses are to be expected. quakes in the region, lasting over a and prolonging the loss adjusting and However, when unanticipated losses year. It was the magnitude 6.3 event claims settlement process. The New occur and an insurance or reinsurance – right beneath the city of Christchurch Zealand Earthquake Commission 19 company radically revises its loss on February 22, 2011 – that proved (EQC) and private insurers are still figures upwards there can be a deadly. Many buildings that had been settling outstanding Canterbury detrimental impact on the business. damaged and weakened in earlier earthquake claims five years later. quakes were reduced to rubble, and "When unanticipated 182 people died. "These important losses occur and an In addition to this low-seismicity area enhancements to the insurance or reinsurance suddenly experiencing earthquake model's liquefaction loss company radically revises shake damage, the main unanticipated component offer a more losses were from the unprecedented its loss figures upwards amount of liquefaction, when saturated precise tool with which to there can be a detrimental or partially saturated soil substantially gauge the likely impact of impact on the business." loses strength causing it to behave like this secondary earthquake a liquid. This phenomenon produced hazard on a book of While catastrophe models and expo- so much damage that thousands sure management tools have evolved of residential homes in the region business." considerably, every major catastrophe were found to be situated on land is a necessary learning experience. This with liquefaction susceptibility too The 2010-2011 earthquakes presented includes the 2010 and 2011 Canterbury hazardous for repairs or rebuilding. an important opportunity to learn more earthquake sequence in New Zealand. They were subsequently designated about the behavior of liquefaction. The within the government red zone and Natural Hazards Research Platform, EQC The magnitude 7.1 earthquake in Sep- demolished. and many local agencies in New Zealand tember 2010 on an unknown fault funded the collection of liquefaction in Canterbury, which was previously The impact of repeated events and the observation data across Christchurch. thought to be a low seismic-hazard large amount of liquefaction created This extensive, high-quality data reveals several key observations, including:

Figure 1. Example of liquefaction that caused significant Figure 2. Example of lateral spreading that caused severe Megan Arnold is a product manager responsible for the development, delivery, and subject matter support of damage to buildings during the Canterbury earthquake damage to buildings and infrastructure in Christchurch during earthquake models. She is currently focused on the New Zealand Earthquake HD Model. sequence. The photo was taken during the RMS reconnaissance the February 22, 2011, earthquake. The photo was taken during trip to Christchurch after the February 22, 2011, earthquake. the RMS reconnaissance trip to Christchurch.

EXPOSURE / RMS.COM French observatory applies Australian insurers forced to process and deliver claims data lessons learned from claims council to act on their claims in a format that provides the key data data insights that city bosses need, without compromising concerns around Another example of harnessing claims In Australia, frustrated insurers shared confidentiality or privacy. How can insurers help experience to inform urban resil- data with a city council after the town ience strategies is from France, where of Roma in Queensland had been This is another exciting application in natural catastrophe losses are inundated five times in six years. Politi- the burgeoning new field of resilience refunded through the national "cat cal pressure was being applied on the analytics. nat system." Property insureds pay insurers to offer universal flood insur- drive the resilience an extra 12 percent premium to be ance following major floods in 2011. covered. All the claims data generated Insurers mapped and published the in this process now gets passed to the addresses of the properties that had Robert Muir-Wood is the chief national Observatory of Natural Risks, been repeatedly flooded and refused research officer at RMS. He set up after Storm Xynthia in 2010. to renew the insurance cover unless analytics revolution? works to enhance approaches This unit employs the data to perform action was taken. The insurers' campaign to natural catastrophe forensic investigations to identify what achieved its goal, pressuring the local modeling, identify models for can be learned about the claims and council to fund flood alleviation measures new areas of risk and explore then works with municipalities to see across the town. expanded applications for how to apply these lessons to reduce catastrophe modeling. Insurers can play a key role in advancing resilience analytics, explains Robert Muir-Wood, RMS future losses. The claims data is not as These examples highlight how insurers comprehensive as it is in Norway, as data can help cities identify where their chief research officer. The application of risk quantification can help make communities, cities and is only collected when the French state investments will accomplish the most countries more resilient, better able to withstand their hazards and lower their levels of risk. declares a "cat nat event," which excludes cost-effective risk reduction. All that's some of the smaller and local losses. needed is an appetite to find ways

The 2015 Sendai Framework for Insurers already play a vital role in to classifying and reporting address- Disaster Risk Reduction, established by resilience. When a disaster strikes, level exposure and claims data cover- the United Nations Office for Disaster insurance provides a source of funds ing all private, commercial and public Risk Reduction (UNISDR), placed a to help homeowners and businesses buildings. Once the classifications were central focus on which policies and pick up the pieces and carry on. consistent it became clear that almost actions will reduce risk. 70 percent of flood claims were driven 21 Although they might not see them- by urban flooding from heavy rainfall. "The [RMS] meeting selves as being in the "resilience" busi- testified that govern- ness, insurers collect far more detailed "Although they might not and precise information on property see themselves as being ments – local, regional damage than any other public or private and national – are begin- sector organization. This claims data in the 'resilience' business, ning to explore their own can provide deep insights into what insurers collect far more determines damage – whether it is the detailed and precise disaster risks." vulnerability of a particular building type or the fine scale structure of flood information on property The first of the four priorities within the hazard. damage than any other Sendai framework is “…an understanding of disaster risk in all its dimensions public or private sector At a recent Organization for Economic of vulnerability, capacity, exposure of Co-operation and Development meeting organization." persons and assets, hazard character- in Paris on flood risk insurance we istics and the environment.” Starting with a pilot of ten municipal- discussed new initiatives in Norway, ities, including the capital Oslo, a France and Australia that harness and In May 2016 in Miami, RMS orga- group funded by the Norwegian apply insurers' claims experience to nized the first international meeting finance and insurance sector took inform urban resilience strategies. on "Resilience Analytics," bringing this address-level data to the city together city chief resilience officers authorities to show exactly where Norway claims data improves and others who work on risk quanti- losses were fication and reduction. The meeting flood risk concentrated, so that the city engi- testified that governments – local, In Norway, where it is the norm for insur- neer could identify and implement regional and national – are beginning ers to share their claims data with the remedial actions, whether through to explore their own disaster risks. Natural Perils Pool, costs of catastrophes larger storm drains or flood walls. are pooled across private insurance com- As a result flood claims are being For insurers and for city officials, the panies. In 2008, this sharing process reduced. priority is the same – quantify the risk. was made more efficient through the But such quantification can be challeng- adoption of a standardized approach ing without data.

EXPOSURE / RMS.COM Turn Exposure Data What Is Your into Risk Insights Exposure Manager, the first solution on the RMS(one) platform Portfolio Really delivering accurate, actionable exposure analytics to risk managers. Worth?

As the market targets greater liquidity, fair value assessment is now a high priority for ILS funds. Crude valuation assumptions are masking true performance.

RMS valuation services link return and value to real risk with independent, consistent, transparent methods.

For a clearer view of your portfolio's true value, contact us at [email protected].

With Exposure Manager, you'll gain a clear view of your risk accumulations – to manage volatility more effectively, understand your exposure in more detail, and avoid a private catastrophe.

• True Accumulation Monitoring: Flexible reporting zones with the most trusted Exposed Limit calculation in the industry • Identify Good versus Bad Risk Hot Spots: Utilize RMS hazard intelligence for informed assessment on where to grow the business and areas to avoid • Assured Response to Real Events: Respond to real-world events promptly and confidently, improving customer service while avoiding miscommunication to stakeholders

For a clearer view of your exposure, contact sales at [email protected].

Exposure Manager POWERED BY RMS(one)®

www.rms.com www.rms.com ©2016 Risk Management Solutions, Inc. ©2016 Risk Management Solutions, Inc. RMS is the world's leading catastrophe risk modeling company. From earthquakes, hurricanes, and flood to terrorism and infectious diseases, RMS helps financial institutions and public agencies understand, quantify, and manage risk.

Risk Management Solutions, Inc. 7575 Gateway Blvd. Newark, CA 94560, USA www.rms.com