Making a measurable difference

Natural catastrophes claim thousands of lives every year and cost billions in property damage. Insured losses from earthquakes, floods and storms are rising as population and wealth become more concentrated in hazard-prone regions. The changing climate may also bring increasingly frequent, intense events. Despite scientific progress, natural catastrophes remain unpredictable – but reinsurers are ever more skilled at modelling their impact on clients’ portfolios and helping to mitigate the volatility they cause.

2010 saw many and severe natural catastrophes, claiming nearly 304 000 victims, with the earthquake in Haiti alone claiming over 222 000 lives. Floods in China and Pakistan and prolonged heat waves in Russia contributed to the toll. European windstorm Xynthia and major earthquakes in Chile and New Zealand claimed fewer lives but caused significant damage to insured property. Three storms in the United States, two hailstorms and the floods in Australia at the end of the year each caused losses in excess of USD 1.0 billion. Topped by Haiti’s devastation, natural catastrophes and man-made disasters cost society more than USD 200 billion in 2010, well above the annual average for the past two decades.

Insured claims, however, were comparatively low at around USD 43 billion. Many hazard-prone regions still have insufficient insurance coverage: for example, low insurance penetration in Haiti led to very small insured claim amounts, despite the huge humanitarian cost of the earthquake. Where insurance penetration is high, as in Chile or New Zealand, much of the loss is transferred to insurers and subsequently to reinsurers. Thanks to their globally diversified business, reinsurers like Swiss Re can absorb local insurers’ peak risks, stabilise their balance sheets and free up capital they would otherwise need to hold. Our ability to release funds rapidly helps ease post-catastrophe burdens on individuals, companies and governments, mitigating the cost of emergency relief efforts, reconstruction and stalled economic activity.

A global leader in sophisticated natural catastrophe modelling

Assessing the impact of natural catastrophes on insurance and reinsurance portfolios demands a deep and evolving knowledge. For 25 years Swiss Re has continuously researched and developed the global natural catastrophe model that we use to gain a clearer view of the risks. We employ and consult with natural scientists, engineers, meteorologists and seismologists, all dedicated to understanding floods, earthquakes, hurricanes, and the damage they cause. Merging data from past events with research of future trends (including climate change), Swiss Re’s expert programmers design computer simulations running hundreds of thousands of catastrophe scenarios, each based on slightly differing initial conditions. For example, a hundred years of data on North Atlantic tropical cyclones have generated 50 000 years’ worth of simulated future hurricane activity. Some of these simulated scenarios are much more extreme than any storm we have seen in the past.

Swiss Re’s model computes potential loss based on the nature of the hazard, the expected damage from varying intensities, the location and value of insured objects and the terms and conditions of insurance cover. For a given insurance portfolio, it calculates an expected loss for each catastrophe scenario and then relates the loss severity to the likelihood of its occurrence. This relationship then provides the basis for setting premiums.

Such a powerful and sophisticated model has many uses: When combined with detailed online maps and country-specific disaster and insurance data, it provides a clear picture of an insurance portfolio’s exposure to various perils, which Swiss Re makes available to clients as CatNet™. We also use it to support business decisions: By aggregating Swiss Re’s entire portfolio across all lines of business and regions and comparing it to our target prices, we can navigate toward the most profitable segments. With this active portfolio steering, we aim to have our Property portfolio outperform the market consistently.

Modelling expertise is also the basis for monitoring our total exposure to major natural catastrophe scenarios, ensuring that the risk we take on matches our risk appetite, and that we have achieved the diversification that underpins our ability to absorb risk efficiently for our clients. When our exposure reaches a pre-determined limit, our risk expertise allows us to repackage parts of that exposure into innovative, tradable, transparent products for capital market investors. These insurance-linked securities transform insurance and reinsurance risks into an investor-friendly asset class. Our unmatched capabilities in structuring such transactions give us a competitive edge in helping our clients to expand their business.

Innovative solutions for a growing market

Parametric products pay when a pre-defined trigger is reached – such as a specific earthquake magnitude or hurricane wind speed. These products offer transparent structures and speedy payment, and are available both as bonds and reinsurance. Swiss Re has been at the forefront of such alternative risk transfer for many years. In 2010, we agreed with the US State of Alabama to provide parametric hurricane protection with fast payouts if an event occurs. The three-year programme is triggered when winds reach 111 mph (179 km/h) in a defined region, and the size of payment is determined by the official hurricane category. The value of such an arrangement is obvious: for communities devastated by a hurricane, prompt cash payment spendable at government discretion can make a real difference.

Another form of risk transfer – insurance-linked securities – first appeared 15 years ago and has since been focused mainly on US risks. Recently though, PERILS (an insurance data organisation that Swiss Re helped to establish) has created a pan-European loss index that enables new growth in securitisation and parametric coverage for European windstorms. Here too, Swiss Re is an innovator, and in 2010 underwrote a bond for AXA that provides the insurer with European wind protection using a PERILS index trigger.

Swiss Re is highly optimistic about the prospects for insurance-linked securities. Demand for natural catastrophe cover will grow, and will draw on the capacity of the capital markets. With annual growth projected at 5 to 7%, the cat bond market seems likely to reach USD 20 billion within a few years. Peak life and health risks – such as pandemics and longevity – are also potential drivers of insurance-linked securities activity.

With Swiss Re’s expertise and continuing research, and our innovative transformation of risks into investable forms, we are confident and enthusiastic about helping our clients and society manage the largest risks that nature has to offer.